Liberal democracy: how did we get here, why is it attacked, and what to do about it. (II) The attacks.

Following Fukuyama (see 1), who understands liberalism much as McCloskey (2) does, as “humane true liberalism”, since 2000 it has been receding due to a number of attacks from different ideologies or realities, (as attested by Freedom House). In consolidated democracies, the liberal insitutions have directly received the attack, (Courts, media, independent state officials and organisms, and all other controlling mechanisms).

It is not the first time it has been attacked, first by the Romantic movement that considered it a cold and useless ideology, later by both communists and nationalists after WWI, then marxists and others. But it regained the field and has served our westerm societies in the last part of the XX century.

What is liberalism? The common features to liberalism are its individualism, (primacy of individual over any collective group) egalitarianism, (all individuals have the same moral value), universalism, (human species is recognized as a moral unity, and specific cultures or historical moments are secondary) and meliorism, (every system can be improved). Liberal societies recognize individuals have rights and specifically autonomy in its main life aspects, (starting in 1800 in a few individuals, then improved to so many other groups). Rights are granted in formal laws that cannot be abused, so that liberalism somehow refers to the rule of law, that restricts the power of the executive power. When considered together with a democratic system, our “liberal democracies” have majoritarily been attacked in the liberal aspect, and even dictators try to maitain prima-facie democratic systems. Liberalism is based on a pragmatic approach as it allows to regulate the violence between groups (so it requires tolerance to diversity), a moral one as it emphasizes the dignity of the individual, and an economic one, (as it generates prosperity).

Before moving forward, two words about the “Rule of Law”, (see 2). Its origin is unclear when going back before the XVII century in England, but the supremacy of law really did matter and survived in England unlike in other European countries, where absolutism reigned. In the XVII century, when Parliament “created” law, discussions between different parties as to the limits of law gave birth to individual liberty, (beyond privileges granted to cities or groups before that). In England, James I and Charles I tried to interfere with it trying to create monopolies, (and other measures), they were fought with the Magna Carta and other arguments, and finally the Stuarts were ousted in 1688 (Glorious Revolution).  Locke´s ideas and the separation of powers were since then critical and core to the Rule of Law, (in the UK, the USA, etc).

Did it fail to comply with its promises?

McClouskey (3) clearly describes its success since 1800. But for FF the ideological dominance of the Chicago University, (Friedman, Stigler, Becker, Von Mises, Hayek and others), and their desdain for the state economic presence, led to a certain excess that later (in the 2010s) generated discontent. Those affected in each country by free trade policies, deregulation in the banking industry, inequality and the reduced capacity of social policies, (liberals thought on personal responsibility and moral hazard in economics aids), …, gave birth to populism starting in 2016, (Trump, Brexit, etc).

The emphasis on property rights, (unequal or unfair as they may have been), the consumer excedent as a measure of welfare (and antitrust activities), the decline in the dignity arising from production activites eaten by big corporations, (Hegel´s view of production and work as a part of human dignity and origin of the thymotic desire for recognition), the Hayekian view that spontaneous self-organization gives birth to the best institutions, …, were perhaps not wrong but applied in excess and without nuances.

Critic of liberalism surging from the left?

Leftists advanced the idea of individual autonomy:

• from within the western moral framework or corpus to the election of the framework itself, (from a philosophical point of view). From a Rawlsian view of justice and the focus on the individual decision-maker, communitarist critics unveil the self-realization above justice, a kind of superiority of an interior self, (Rousseau), so that restrictions -framework included- are not welcome.

• and to groups in which individuals are included, (from a political perspective). The groups are identified for specific features of individuals, (race, gender, etnia, etc). It started in the 60s in USA in a fight of certain excluded groups for their equal rights, so that liberalism could broaden. But things were further to propose illiberal ideas; Marcuse (4) talks about societies led by elites converting people in consumers, (killing their liberty) and started defining freedom not in terms of economic classes but in terms of groups constituted not voluntarily but existing due to race, etnia, etc.

Extreme leftists in the USA go even further, to reject the possibility of a rational discourse, (remember liberals base their thinking in the natural science where the object is out of the mind, -Descartes, Bacon-). Max Weber made a difference between facts -objective- and values -relative-, and the critic is founded on a complete moral relativism, including facts, (epistemic relativism, Nietzsche, Foucault). Language is also considered not an objective tool, but one used by the powerful to dominate groups of people, (thus the effort to change our use of language). Also the existence of a common moral corpus once culture and experience is set aside is undermined, based on the identity and different experience of groups. And right movements adopt it partially, exposing the attack that WEIRDs are suffering, (western, educated, industrialized, rich and democratic).

Technology, privacy and free speech.

One of the main liberal principles of liberalism is the freedom of thought and speech, and are both foundation for many other individual rights. It requires free and diverse (not too concentrated in the hands of governments or oligarchs) press, and respect for privacy, (inside a certain circle, even when individuals express their opinions -with their words-; they must be free to do it without the threat of being cancelled). An additional problem is the (in the time of online media and social networks) excessive and inappropriate consideration that irrelevant voices have to a great number of themes, (health for example), as scientific and reliable voices get lost in the irrelevancy or within the reduced circle of experts.

Nationalism.

This is another aspect where liberal globalism, and its universal values receives a critic, as power still remains with the natio-state. Somehow this allowed the far right to control nationalist movements where certain aspect of identity play a role.

After the criticism, what alternatives are presented to liberal societies.

Liberalism requires a certain space of common values that tie the members of society up. Respect for religious values, culture, biology, for the family, tradition, etc., as connectors among individuals as autonomous as they may be is important, as Ahmari and Vermeule state. And liberalism somehow dismantled this, with its adherence to diversity and tolerance (populist right view, that sometimes lets arise authoritarianism as a solution -Modi in India-, and sometimes gives birth to some form of common good constitutionalism -Vermeule-).

The left exposes inequalities due to identity as a main defect; emphasis on open borders, expanded social-democracy with massive taxes to the “rich”, is what lets us imagine their vision of a post-liberal society.

(To be followed).

1.- Liberalism and Its Discontents : Fukuyama, Francis: Amazon.es: Libros

2.- The Constitution of Liberty, Hayek, (Chapter 11). The University of Chicago Press, 2011.

3.- Why liberalism works, 2019, Yale University Press. Deirdre Nansen McCloskey

4.- One Dimensional Man, by Herbert Marcuse (contents)

Liberal democracy: how did we get here, why is it attacked, and what to do about it. (I)

Francis Fukuyama published (1992) “The End of History and the Last Man”, in a time when (after the science-based optimism of the XIX century, pessimism in the first half ot the XX century) peace, progress, and fall of strong illiberal states had let open space for optimism again. Liberal societies started to dominate.

Political liberalism requires the Rule of Law, which entails Civil, (respect for the individual), religious and political rights. Economic liberalism means free economic activity based in property rights and markets. Liberalism does not necessarily go hand in hand with democracy, and transition into such a system is not easy, due to legacies and resistance.

In the book FF analized the directional nature of History from Old to Modern, and identified liberal democracy as the final step according to reality after the collapse of communism in 1989, following Hegel´s dialectic view, and against the also dialectic view drafted by Marx, who saw the final step in the dictatorship of the proletariat.

Hegel picked Plato´s view of the soul as divided in three, desire, reason and thymos or spiritedness. Men´s demand or need for recognition (from others) emanates from the last one, thymos.

In Hegel´s view, it is the Struggle for Recognition that moves History, starting with the origin of a society of masters (who thought of themselves as better than others and deserving recognition from them as better) and slaves, the former putting their lives at risk to be recognized and the latter embracing self-preservation while accepting slavery. Every “statu quo” of this kind generates insatisfaction that is dialectically solved thanks to a transition to the next system in History, (serfdom, tyrannies, dictatorships, etc.), until a system is well defined in such a manner that there is not a sufficient lack of recognition that could trigger the next revolution, and according to Hegel and Fukuyama, this system is the liberal democracy.

Desire and reason explain progress and prosperity, but democracy needs the demand for recognition to be understood. Economic and scientific progress needs moral progress, intellectual consistency, and when this does not hold, fascism, communism or other factors generate time lapses in which liberal democracy is lost, some of these regimes being “totalitarian” not just illiberal, (they destroy any space of human liberty). These periods may last too much, (although Fukuyama thinks differently, in History timings), as in communism, the time of several generations.

Fukuyama thought the End of History could have arrived, so that there will be no alternative as a system that fulfills all human needs and in particular a feeling of fairness and relative equality, (recognition). For Fukuyama History is directional, follows an upward slope path elevated by increasing knowledge and science, and cannot be reverted, as there are not powerful enough forgetting mechanisms; knowledge does not disappear, even the worst regimes need it to keep its control over the population and defend their controlled territory against others, (think of the taliban, etc., they need weapons and progress).

Let´s introduce an ex-cursus here, so that we can discuss the reasons of progress and sufficient satisfaction in a liberal democracy, following some other authors.

a) Prof. McCloskey, (see 2 for example), explains why liberalism works; adopting from Axel Kaiser the concept of modern liberalism, (humane true liberalism) she recalls “social equality, economic liberty and legal justice, with a small restrained government truly helping the poor” from Adam Smith, (see -3-). She remembers liberalism since 1800 has brought a huge increase of income of the poorest (by 3000%). She defends liberals are democrats, (restrictions in collective decision normally do not improve the wisdom of crowds; individuals left to themselves in markets achieve fantastic results).

b) Martin Wolf, in his most recent book, see (4), addresses the relationship between liberal democracy and economic capitalism. He thinks there is a need to reform this relationship so that democratic capitalism continues to deliver the results societies need to validate their systems. But he asserts they reinforce each other, perhaps since a certain level of wealth, educational level and equality has been reached.

c) Acemoglu y Robinson describe that (to the detriment of geography, culture, religion or other factors), institutions have been critical to the success of nations. Both political and economic inclusive institutions are needed for that success, (again the combination of policital participation and economic freedom), see (5).

d) Timothy Beasly states that a strong and fiscal state and democratic traits are needed for prosperity, (science can enlarge the boudaries of possibilities, but there is a need for a society that provides the means for this “technically possible enlargement”), see (6).

e) Also Acemoglu and Robinson in that same sense (see 7), when analizing how to transform a country into a well governed, prosperous, law-abiding, democratic and free society, they assert liberty stems from a balance between state and society. Different from a (Hobbesian) Despotic Leviathan, and also from an Absent Leviathan, (totally absent or present as a set of custom norms determining behavior -like in Indian caste system-), but in-between, the authors see a narrow corridor, where society and state run in parallel and are balanced, and they call it a Shackled Leviathan.

(To be followed).

1. The End of History and the Last Man, 1992, The Free Press, a division of Macmillan, Inc. New York. Francis Fukuyama
2. Why liberalism works, 2019, Yale University Press. Deirdre Nansen McCloskey
3. Adam Smith: The wealth of nations, 1776, The Wealth of Nations | PDF | Mercantilism | Adam Smith
4. Martin Wolf, “The Crisis of Democratic Capitalism”, 2023
5. Why Nations Fail: FROM THE WINNERS OF THE NOBEL PRIZE IN ECONOMICS: The Origins of Power, Prosperity and Poverty : Acemoglu, Daron, Robinson, James A.: Amazon.es: Libros
6. https://en.wikipedia.org/wiki/Tim_Besley
7. https://www.amazon.com/-/es/Narrow-Corridor-States-Societies-Liberty/dp/0735224404/ref=sr_1_1?crid=30Q5EPO9POKFY&dib=eyJ2IjoiMSJ9.axCvS-MTL5ZRKoQoZ94A48D2T4EUQo5Mq8zz7R-lpy8OJfoh-_IubA7zTSkBSH9_xb4eW-AqVh28Uiabb9PODJEqKOVgbst7_YHDb5XmqUk.aXIWUbvN9eRQMxIx-2RjMfB4asgIs4N_eHK1gi-_vwk&dib_tag=se&keywords=the+narrow+corridor&qid=1769795016&sprefix=the+Narrow+Corridor%2Caps%2C277&sr=8-1

Fiduciary Duties, Business Judgement Rule, Entire Fairness Standard of Review and Execpay

We will review in this post a thorough analysis by Anna Restuccia, (Hardvard Law School), on the Delaware court decision on 2018 Tesla´s compensation plan for Elon Musk. (1)

Elon Musk pay scheme as it was setup in 2018 has faced a setback as Delaware Courts have ruled board members did not act well. He was offered 12 stock option tranches (for 1% of outstanding shares each) each tranche to vest under certain cumulative conditions (50 billion in market capitalization increase each, plus some sustainable adjusted Ebitda or Revenue targets). Grant date fair value was establised at 2,6 billion, and maximum package was up to 55,8 billion. Pay opportunity was some 33 times bigger than his last pay package and some 250 times its peers higher schemes.

The plaintiff argued that this decision was taken in a conflicted controller-stockholder situation; Elon Musk held 21,9% of Tesla shares, he was the founder, powerful CEO and Chair; he also had strong ties to some directors deciding on the matter and dominated the decision-making process that led to the pay package. This implied that Courts should use an entire fairness standard, so that the defendant should prove that the plan was fair. Only if the decision had been taken by a majority of the minority shareholders on an informed way could the defendant have avoided this standard, and the plaintiff argued the decision was not informed.

Settling with Activist Investors and directors´Fiduciary Duties.

When interacting with activist investors, boards (should not we say shareholders?) often grant them some board seats in exchange for their proxy fight withdrawal. According to Neil Whoriskey, (1) this exchange means handing over something valuable, which will lead Delaware courts to apply the Unocal test, as this should be considered a defensive device, (like a poison pill, greenmail, etc). According to the Unocal test, directors detecting a threat to corporate policy or effectiveness, and introducing a proportional and reasonable defensive measure, would be granted the fit with their fiduciary duties.

The author considers the questions and certainties boards should make and have before granting partial control ot the company to a third party, in regard to the different duties.

Expropriating control: the case of Rights Offers

Leeor Ofer has just published a post in the Harvard #Corpgov blog, (1) where she summarizes her forthcoming article on “Control Expropriation via Rights offers”, (2).

A rights offer is a way to raise capital, on a current shareholding pro-rata basis, normally offering a discount on the trading price. Shareholders can then use the right and buy the shares, thus keeping their pro-rata on the company´s equity, (or sell their rights and get the discount value, if this possibility exists, and the market for the rights is efficient).

Rights offers are advantageous: (i) they may not require a shareholder approval if a previous general approval is in place; (ii) undervalued issuers may use it and avoid granting value to third parties; (iii) transaction costs are reduced; and (iv) as rights offers grant all shareholders the same options, the business judgement rule (BJR) is easily applied to these board decisions aiming at organizing a rights offer.

There is a possibility that dominant shareholders or insiders use the rights offer in order to acquire cheap stock, so as to improve the value to be captured by their investment, as small shareholders might not have enough funds, or could face uncertainty over whether the share is over or underpriced, thus using only a part of their rights to actually acquire shares, (cheap-stock tunnelling, as Fried and Spamann have recently argued (3)).

Rights offers designed to achieve control this way or the way explained below, avoiding takeover requirements and stricter fiduciary duties´control, can harm corporate governance standards.

Leeor Ofer explains that a third expropriation method may be used by dominant but non-controlling shareholders. If the offer is overpriced, (completely outside the uncertainty price area), even absent all other impediments, outsiders would avoid participating in it. This is why insiders would be able to increase their control, and afterwards extract private benefits (making the price attractive), to the detriment of minority shareholders.

Twitter, Musk and the Stakeholder Theory in practice.

Lucian A. Bebchuk, Kobi Kastiel, and Anna Toniolo have just published an interesting view on the acquisition of Twitter by Elon Musk and its consequences in terms of Corporate Governance, (1). I have recently posted some comments on the Stakeholder Theory, both presenting it and analyzing its true possibilities in practice, (some of them referring to Prof. Bebchuk articles), (2).

The battle took place in 2022, and was won by Twitter so that Musk had to keep its offer to the last USD, after trying to renegotiate the deal terms. Shareholders and probably managers obtained all their proceeds in full, …, but did other constituencies get also good results? Let´s see if this was the case.

Stock blockholders do not use to take a board seat. Why?

Alex Edmans (1) published in 2013 a study on the methods blockholders use to influence their investee firms, and signaled voice, exit (or the threat of executing them) and private benefits extraction. After reviewing the theoretical literature, he analyzes the empirical evidence, (profitability versus different blockholderism metrics). The relation  is a two-way avenue, (which affects the causal relationship identification), but both the positive governance effects of blockholders and the cost of their presence have been found.

But if this is the case, why is it that blockholders do not generally seek to take a seat on the board of companies they invest in? This is what Samed Krüger, Peter Limbach, and Paul Voß try to understand in their (2) article “Blockholder representation on the board: Theory and Evidence”. In this post we will try to expose their views.

Their first insight refers to the low costs of taking the seat, (positions are paid and eventual costs of attending meetings are low relative to amounts invested). But it is an empirical fact that blockholders do not often join boards; the ideas promoting their model and empirical research are described in aht follows:

• An indirect cost of the announcement of the representation may arise if outside shareholders generate a negative stock price effect, (this would reduce their trading options, and is hypothesis H1). This may happen as the entry reveals an agency problem, even if it also signals a governance improvement to come, (enhanced advise or monitoring). This is their hypothesis H3.
• Also, the fact that a director is granted access to insider information, the freedom to trade the company stock may be reduced.
• A seat on the board may also be considered a last resort option for the blockholder, when unseen engagement does not work.
• Moreover, freedom to exit may be reduced, so staying investee and being forced to exert effort to increase the company value may be a harm in cost and investment timings, (hypothesis H2).

Maximizing company value and fiduciary duties. Not so simple.

A lawsuit was introduced on October 3^rd 2022 against directors of Meta, (previously Facebook), adducing they breached their fiduciary duties and damaged interests of “diversified shareholders”, not in their stakes in the company, but because of alleged damages to the value of their other investments. This sounds very odd, but there is an argument. Let´s try to unravel the knot, following the Harvard Law School Forum on Corporate Governance, (1)

The complaint is based on the “shareholder primacy model”, (2) but considers not only the residual interest of common shareholders in the (maximum possible) cash flows and value to be received as common share owners, but beyond that, refers to the effect of board and directors´decisions on their other equity and debt investments, as institutional and even retail investors are generally diversified. The argument by McRitchie (the shareholder starting the procedure) refers to activities by Meta that entail political instability, damages to mental health overall and the rule of law, etc., thus endangering the value of their other investments, even if Meta value could be considered to be maximized, (all efforts by directors are guided to maximize revenue irrespective of these other public goods). The filing comes after some shareholders´proposals urging the board to consider these eventual damages were disregarded.

The filing does not consider actions by directors harmed stakeholders interests; it does not consider either that value in Meta shares was not maximized; it refers to shareholders other investments, (they are broadly diversified, as Institutional Investors -II onwards- own a majority of the market´s shares, over 75%).

Excessive Risk Taking. Why we do not learn.

In the midst of a political turmoil in the UK political arena in October 2022, a new crisis event was more or less disguised by the big picture, but is relevant enough to be mentioned, as it affects risk taking, long-term investment strategies, pension funds, employers as contributors to pension funds, etc.

It is well known that pension funds generally invest in so called safe assets a large part of their funds, in order to secure enough future cash flows to be able to serve their pension liabilities. In a QE environment, I which Central Banks provided huge amounts of cheap money in addition to reducing interest rates to historical lows, income derived from the fixed-income assets portfolios were considered to be to low to satisfy the funds´ future liabilities.

A strategy was then (again, facilitated by big finacial players, such as Blackrock, Schroeders, Legal & General Group, and others), introduced in order to maintain future income stable; LDI (liability driven investment) hedging strategies consisted in lending part of the portfolio bonds, so that hedging against falling rates effect on prices was achieved; received funds were used to reinvest in bonds, securing additional future income.

But when using this strategy, you need to be aware of the fact that sometime in the future, interest rates might rise again, as Monetary Policy could eventually change. Bets were not thinking of recent developments in energy markets, the war in Ukraine, inflation at levels not seen in decades, etc. And rates went up, and QE was to be reversed, and expectations began to reflect this. Interest rates went up in some long-term parts of the curve, and of course monetary policy started to tighten.

Hedging providers started to require additional cash from Pension Funds to cover hedging losses, and the result could not be worse, as everything joined with an irresponsible political move by the new Prime Minister Truss, which entailed a huge international bond sell-off. This altogether produced a fast and huge increase in bond yields in the markets, that could only have meant a huge iterative sell-off by Pension Funds further putting pressure on the same mechanism. Only a buyer (the Central Bank) could intervene and stop the destructive process. And it did, thus saving Pension Funds´s situation.

Some changes need to be introduced in the portfolios before the Central Bank is forced again to undo their QE, so that a huge volume of gilts (UK bonds) are released from its portfolio thus flooding the market.

I hate the sentence “this is not going to happen”, (except when the one saying it has the capacity to prevent that to happen, which normally is never).

See: https://worldnewsera.com/news/entrepreneurs/analysis-the-pension-fund-strategy-thats-plaguing-the-uk-bond-market/

Corporate Governance and the Twitter Board decision on Musk´s offer

Columbia University Law Professor Jeffrey N. Gordon recently starts a brief entry in the Oxford Law blog showing his surprise that the only reason the Twitter board apparently considered to accept Mr Musk´s offer was the interest of shareholders; moreover, he seems bewildered that public welfare, the forecast of Mr Musk´s management, the effect of the change in control on Twitter´s infrastructure had been ignored. Difficult to understand his surprise from a Shareholder primacy perspective, but mainly if fiduciary duties are considered, …, how should directors have acted? Let´s see how Prof. Gordon sees this.

According to his interpretation of Delaware corporate law, directors could have dismissed the offer on grounds of other stakeholders´interests, eventual externalities to be imposed by Mr Musk on society, or even on grounds of an eventual long-term valuation of the company which might have been considered higher than the offer price, (the last one seems to be reasonable, but board may well have analized and rejected this).