introduction: why transystemic business...

Business Associations ReadingsProf Janda, Winter 2005

INTRODUCTION: WHY TRANSYSTEMIC BUSINESS ASSOCIATIONS LAW?................................................................3January 6, Class 1: Introduction and Review of Teaching Methodology............................................................................................................3

Sainte Fare Garnot, Rémy...........................................................................................................................................................................3PART 1: THE FORM AND FUNCTION OF CORPORATE LAW: CORPORATE LAW AS THE CONSTITUTIONAL LAW OF MARKET ACTORS.........................................................................................................................................................3

Parallel VanDuzer Readings: Chapter 3, Parts C-F & Chapter 4 Part C.....................................................................................................3January 11, Class 2: What is the role and function of corporate law?.................................................................................................................3

Eisenberg, Melvin A....................................................................................................................................................................................4Eells, Richard...............................................................................................................................................................................................4

January 13, Class 3: What is the relationship between state law and the corporation’s internal rules?...............................................................5Millstein, Ira M.. and Katsh, Salem M........................................................................................................................................................5Romano, Roberta.........................................................................................................................................................................................7

PART 2: THE THEORY OF THE FIRM: WHY FIRMS, WHY CORPORATIONS AND WHY SEPARATION OF OWNERSHIP AND CONTROL?....................................................................................................................................................9

Parallel VanDuzer Readings: Chapter 3 Part G, Chapters 1 & 2................................................................................................................9January 18, Class 4: Why are there firms rather than a web of individual contracts?..........................................................................................9

Coase, R.H...................................................................................................................................................................................................9January 20, Class 5: What are the different legal forms of business association?.............................................................................................12

See also VanDuzer Chapter 1, Part C........................................................................................................................................................12Klein, William A. and Coffee, John C. Jr..................................................................................................................................................12

January 25, Class 6: What is the Business Trust?..............................................................................................................................................13January 27, Class 7: What is the relationship between ownership and control in business associations?.........................................................13

Berle, Adolf A. and Means, Gardiner C....................................................................................................................................................13Chandler, A.D. Jr.......................................................................................................................................................................................15D.S. Pugh...................................................................................................................................................................................................18Bourdieu, Pierre.........................................................................................................................................................................................18

PART 3: THE EMERGENCE OF LEGAL PERSONALITY OF THE CORPORATION: COMPARATIVE HISTORY, JUSTIFICATION AND RELATION TO SOCIOECONOMIC FACT.....................................................................................19

Parallel VanDuzer Readings: Chapter 3 Parts C & H, Chapter 4 Parts B & D.........................................................................................19February 1, Class 8: How do the emergence of and changes to the corporate form relate to changes in economic relationships?..................19

Clark, Robert Charles................................................................................................................................................................................19February 3, Class 9: What, in comparative perspective, are the historical underpinnings of corporate legal personality and limited liability?............................................................................................................................................................................................................................20

Perrott, David L.........................................................................................................................................................................................20Ouchi, William G......................................................................................................................................................................................24Lefebvre-Teillard, Anne............................................................................................................................................................................25Hurst, James Willard.................................................................................................................................................................................26Hovenkamp, Herbert.................................................................................................................................................................................27Handlin, Oscar...........................................................................................................................................................................................28Horwitz, Morton J......................................................................................................................................................................................29

February 8, Class 10: What is the legal, economic and social significance of corporate legal personality?.....................................................30Samuels, Warren J.....................................................................................................................................................................................30Lizée, Marcel.............................................................................................................................................................................................32Easterbrook, Frank H. and Fischel, Daniel R............................................................................................................................................32

PART 4: AGENCY, FIDUCIARY RELATIONS AND THE CORPORATION: THE DEPLOYMENT, ORGANIZATION, AND REINFORCEMENT OF TRUST.......................................................................................................35

Parallel VanDuzer Readings: Chapters 5, 8 & 9.......................................................................................................................................35February 10, Class 11: What is the role of fiduciary relationships within the corporation?..............................................................................35

Dent, George W. Jr....................................................................................................................................................................................35Frankel, Tamar...........................................................................................................................................................................................37Hart, Oliver................................................................................................................................................................................................39Easterbrook, Frank H. and Fischel, Daniel R............................................................................................................................................40

February 15, Class 12: How does the law protect corporate fiduciary obligations?..........................................................................................42Kraakman, Reinier.....................................................................................................................................................................................42Teubner, Gunther.......................................................................................................................................................................................43Chapman, Bruce........................................................................................................................................................................................46

February 17, Class 13: For what range of stakeholders are corporate fiduciary obligations recognized and protected?..................................48Macey, Jonathan R. and Miller, Geoffrey P..............................................................................................................................................48

PART 5: CORPORATE GOVERNANCE: ECONOMICS, MANAGEMENT AND COMPARATIVE LAW PERSPECTIVES ON THE LEGITIMATION OF POWER IN THE CORPORATION........................................................49

Parallel VanDuzer Readings: Chapters 6 & 7...........................................................................................................................................49March 1, Class 14: What is the relationship between corporate fiduciary obligations and corporate governance?..........................................49

Fukuyama, Francis.....................................................................................................................................................................................50

Jensen, Michael C. and Meckling, William H...........................................................................................................................................51March 3, Class 15: What are the legal contours of the problem of corporate governance?...............................................................................52

Bybelezer, Henri M...................................................................................................................................................................................52Iwai, Katsuhito...........................................................................................................................................................................................53Blair, Margaret M. and Stout, Lynn A......................................................................................................................................................56

March 8, Class 16: What light does the Management literature shed on the problem of corporate governance?.............................................59Mintzberg, Henry and Quinn, James Brian...............................................................................................................................................59Mintzberg, Henry and Quinn, James Brian...............................................................................................................................................60Drucker, Peter F.........................................................................................................................................................................................62

March 10, Class 17: What does one learn from a comparison of leading domestic corporate governance regimes?........................................63Maher, Maria and Andersson, Thomas.....................................................................................................................................................63Tunc, Andre...............................................................................................................................................................................................66Jensen, Michael J.......................................................................................................................................................................................67Miller, Merton H........................................................................................................................................................................................70Kester, W. Carl..........................................................................................................................................................................................71Barr, Graham, Gerson, Jos and Kantorm, Brian........................................................................................................................................73Pastre, Oliver.............................................................................................................................................................................................75

March 15, Class 18: Is there an emerging transnational corporate governance regime?...................................................................................75Farrar, John H............................................................................................................................................................................................76Lecture, Berger..........................................................................................................................................................................................78Visentini, Gustavo.....................................................................................................................................................................................80

March 17, Class 19: Does contemporary corporate governance reflect injustice in corporate law?..................................................................82O’Neill, Terry............................................................................................................................................................................................82Dallas, Lynne.............................................................................................................................................................................................83Carver, Anne..............................................................................................................................................................................................85

PART 6: TAKEOVERS: THE NORMATIVE FRAMEWORK OF THE MARKET FOR CORPORATE CONTROL....86March 22, Class 20: How does the corporate governance regime structure the market for corporate control?.................................................87

Coffee, John C. Jr......................................................................................................................................................................................87March 24, Class 21: What is the relationship between internal and external governance of corporate control?...............................................88

MacIntosh, Jeffrey.....................................................................................................................................................................................88Easterbrook, Frank H. and Fischel, Daniel R............................................................................................................................................91Gilson.........................................................................................................................................................................................................91Roberta Romano........................................................................................................................................................................................91Ron Daniels...............................................................................................................................................................................................91

PART 7: THE GLOBALIZED FIRM: MULTINATIONAL CORPORATIONS AND NETWORKED FIRMS.................92March 22, Class 22: What are the legal implications of the multinational and transnational firm?..................................................................92

Pauly, Louis W. and Reich, Simon............................................................................................................................................................92Mabry, Linda A.........................................................................................................................................................................................94Muchlinski, Peter.......................................................................................................................................................................................96

March 24, Class 23: What are the legal implications of transnational strategic alliances and networked firms?..............................................99Autunes, José Engrécia..............................................................................................................................................................................99Castells, Manuel......................................................................................................................................................................................102Evans, Philip and Wurster, Thomas S.....................................................................................................................................................103

PART 8: CORPORATE SOCIAL RESPONSIBILITY: FROM LEGITIMATE GOVERNANCE TO RESPONSIBLE CITIZENSHIP...............................................................................................................................................................................104

Parallel VanDuzer Readings: Chapter 12................................................................................................................................................104March 29, Class 24: What is the legal foundation of corporate social responsibility and corporate citizenship?...........................................104

Jacoby, Neil H.........................................................................................................................................................................................104Klaus J. Hopt and Gunther Teubner........................................................................................................................................................109Krause, Detlef..........................................................................................................................................................................................109Tichy, Noel M., McGill, Andrew R., St. Clair, Lynda............................................................................................................................111Fombrun, Charles J..................................................................................................................................................................................112

March 31, Class 25: Can the state remain the regulatory foundation of corporate social responsibility?.......................................................114Graham, Cosmo.......................................................................................................................................................................................115Hamilton, Walton....................................................................................................................................................................................116Berle, Adolf A. Jr....................................................................................................................................................................................117

April 5, Class 25: Conclusion: Can corporate law be just?..............................................................................................................................118Green, Ronald M.....................................................................................................................................................................................118Eells, Richard...........................................................................................................................................................................................119

business associations readings 2

INTRODUCTION: WHY TRANSYSTEMIC BUSINESS ASSOCIATIONS LAW?January 6, Class 1: Introduction and Review of Teaching MethodologyThis text illustrates one way in which comparative law enters into the practice of a transnational business enterprise. Read it with a view to thinking about how a transystemic approach to business associations could improve the conceptual apparatus of the jurist and practitioner.

Sainte Fare Garnot, Rémy « Des juristes au service d’une entreprise industrielle opérant au plan international », L’Entreprise et le droit comparé, (1994) Société de législation comparée, France, 51Three problems in integrating legal dimension in the practices of business associations:

1. Informing the people concerned;2. persuading them:3. Translating the rules into operational terms

practical approach to law of business associationsLawyers, specialists in the law of one country (one in which envisaged investment will take place) can provide an initial “panorama” of the principal difficulties and opportunities presented by the situation. Lawyers get the technical information they need to do their job from the engineers, business managers etc.What about an international business?Corporate lawyer often faces methods/ concepts from foreign law systems. To accomplish his/her goals, they will often have to use “other” law.Utility of comparative methods: source and catalystTo be efficient/effective, one cannot get blocked in one’s own universe. Lawyer who can use only one law system will be handicapped in context of international business. A well-practiced and effective technique in one system which has become a reflex won’t necessarily work in another. There’s a real need for pure creativity. One must take advantage of the freedom being able to draw from different legal systems allows for. Indispensable complement: the organizational methodFor a project to be successful, always have to begin by clearly defining objectives. This is necessary to figure out what actions to take; make legal choices (because there’s always more than one option). All individuals involved must discuss the objectives so nothing’s implicit/unclear, allowing risk to be calculatable. This allows the transposition of actions to the legal domain.Defining objectives is also an effective technique which allows for the verification of the coherence of the proposed solutions.ConclusionThe business association is aware of the risk it undertakes by existing; it looks to law for security. Business lawyers must explore, discover, and evaluate, but they can’t limit themselves to researching legal systems. They must adapt to the business world and in this task, the comparatist will distinguish himself.

PART 1: THE FORM AND FUNCTION OF CORPORATE LAW: CORPORATE LAW AS THE CONSTITUTIONAL LAW OF MARKET ACTORS

Parallel VanDuzer Readings: Chapter 3, Parts C-F & Chapter 4 Part C

January 11, Class 2: What is the role and function of corporate law?


The first two readings explore corporate law as the constitutional law of market actors. This analogy gives shape to the course, which will consider the corporation as a locus of governance and authority.

Eisenberg, Melvin A. The Structure of the Corporation – A Legal Analysis, Introduction (1976) Little, Brown and Company, Boston & Toronto, 1 “Corporate law is constitutional law; that is, its dominant function is to regulate the manner in which

the corporate institution is constituted, to define the relative rights and duties of those participating in the institution, and to delimit the powers of the institution vis-à-vis the external world.”

general principles governing legal structures of corporations not well articulated; however, there is a more/less standard “pyramidal” image (a.k.a. received legal model) (bottom: shareholders, who choose middle: BoD, which selects top: officers). According to this model BoD manages corp’s business and makes policy, which is carried out by officers acting as agents. Shareholders thought to decide on major corporate actions including fundamental changes.

BUT this doesn’t fit the normal agent-principal relationship: “Under the received legal model of the corporation, however, the officers are agents not of the shareholders but of the board, while the board itself is conceived of not as an agent of the shareholders but as an independent institution. For example, while the authority of an agent can normally be terminated by his principal at any time, directors are normally removable by shareholders only for good cause shown. Similarly, while an agent must normally follow his principal’s instructions shareholders have no legal power to give binding instructions to the board on matters within their powers.”

The received legal model does not work in either a normative or descriptive way. o descriptively, it is insufficient because it doesn’t accurately describe what any of the

parties do – eg the Board does not typically manage corporate business or set policy; similarly there are modern “fundamental changes” (business combinations other than mergers, corporate divisions) which do not require shareholder approval.

o normatively it is insufficient, as it fails to recognize the fundamental differences between closely- and widely-held corporations. Also, the model is insufficiently articulated to provide useful guidance on how to understand the actual allocation of power between shareholders and management.

Eells, Richard The Government of Corporations, 15 (1962) The Free Press of Glencoe, New York, 252Corporate Governance as Compromise

Dynamics of corporate governance: constant process of resolving the competing claims of the various contributors to the enterprise, internal (all levels of employees and directors) and external (stockholders, creditors, customers, suppliers, competitors, general public).

Directors and managers must weigh contributor-claimant interests – bargained compromises Ideally: general interest for the corporate community (analogous to “public interest”) that is not

identical with the bargains struck at the level of top corporate commandThe Public Interest and Corporate Community Interest

Important sources for the norms of equity and fair dealing beyond the limited arena of interest conflict and bargaining, within the corporate community itself (incl shareholders)

Consider two relationships:o Between stockholders and the corporate governing group (we focused on in class)o Between employees and the managerial elite

Decision making as institution building; want social institutions that serve human values fundamental to a free society and do (or undermine) this through corporate policy

Stockholding and the Institution of Private Property


Two (extreme) positions: shareholders are too well treated, as they do nothing and make money, and; management’s responsibility is precisely maximizing share value.

Underlying question: what kind of property rights in shares are there? Private collectivism: wide dispersion of ownership, and rights of owners attenuated because of

collective control at a managerial centre Separation of ownership and control: necessary for the emergence of corporate enterprise Merging of private capital into the great private collectivities, the corporation Most shareholders care about the value of their shares, and not about corporate governanc A shareholder’s confidence that his place within the system is secure can be restored only be

appropriate action in the private governments of these enterprises Common ownership and management of capital aggregations in the corporation, because of the

governmental structure of corporate enterprise, led to wider separation of ownership and control than in other forms of pooling such as partnerships and limited partnerships. The important traditional rights of a property-owner to manage and control his private property was thus lost

The share certificate is not even a claim against an aggregate of capital in a specific corporate enterprise, but merely a claim against a financial institution which has a claim against someone who has a claim against someone (pension fund, profit-sharing trust, investment company, mutual fund)… eventually who has a claim against the corporation.

“passive recipient” shareholders: they’ve lost the traditional sense of responsibility over the use of their property; “true capitalists,” people who invest their own money in their own enterprise, are a thing of the past.

Movement to society in which power, and not ownership is the organizing principle Another issue: shareholders are often not individuals, but aggregate holding

Employee Freedoms freedom of inquiry, of utterance, of association (think collective bargaining), religion constitutionalism is moribund when practical safeguards are neglected. Need safeguards in the

private sector too (not just freedom from encroachment by government) Also need to conceptualize freedoms as the development of personal attributes Eels advocates having company policy to this effect, i.e. framing employee freedoms in a positive

sense Potential problems: legal bars (corporation does not want to be sued in libel because of something

an employee said); economic rewards (intellectual property); political activity The corporation is a new kind of community within the greater community

Conclusion Corporate governance in its dynamic aspects and with respect to the internal affairs of a company

involves the formulation of policies whose norms are only partly drawn from compromise Other formative influences: external influences that condition “deals” – institutional demands of a

free society operate on corporate policy-makers who take the long view Private property as a social institution

January 13, Class 3: What is the relationship between state law and the corporation’s internal rules?The corporation is both given its constitution and gives itself its constitution. These readings explore the relationship between state law and the corporation’s internal law. Roberta Romano, in particular, canvasses the "market" among jurisdictions for the chartering of corporations and thus how state law can be seen as a product catering to corporate preferences.

Millstein, Ira M.. and Katsh, Salem M. The Limits of Corporate Power – Existing Constraints on the Exercise of Corporate Discretion, 1 MacMillan Publishing Co., Inc., New York, 1 (1981)


the business corporation is a legal creature which evolved to enable investors to share the large-scale risks related to large business ventures like RR; had further advantage of limited liability for corporation’s debts and obligations. Initially business charters granted only by act of state legislature; general incorporation statutes were passed in late 19th C. State corporation laws set forth procedures and formalities for corporate action – describe duties and liabilities of BoD, shareholders, etc. Federal standards are overlaid on state corporation law and influence the processes of corporate management and decision-making: e.g. federal securities law.

STATE LAW -- General Corporation Law of the State of Delaware – most popular among large corporations; has had large effect on enactment, implementation and revision of corporate laws in other states. Historically had minimal restrictions on corporate management but recently case law has restricted. NY is second most popular state for incorporation despite “restrictive” statute – management discretion is limited in favour of shareholder and creditor interests. The Model Business Corporation Act (MBCA) has been adopted in substance in 35 states and is major point of reference – is liberal towards management discretion but is more responsive to shareholder interests.

“All state corporation statutes follow similar lines insofar as they establish that corporations are chartered by the state and are free to act only in accordance with their organic charter and the state’s statutory requirements.” (p 14)

Corporate Formalities – “State corporation laws are almost exclusively concerned with the creation and internal governance of the corporation; in particular, with the relationship of shareholders to management.” Certain actions (intended to limit management’s ability to unilaterally alter corporation’s basic structure and scheme of governance) have always been exclusive to shareholders:

o election of directors – generally have to be elected by shareholders at annual meetings.o adoption of bylaws – historically job of shareholders, now commonly adopted by directors.o merger, consolidation, or other “Organic” changes – in all states, shareholder approval is

required to merge/consolidate with another corporation; to sell all/most of the corporation’s assets; to dissolve the corporation; to reduce its capital; or to amend its certificate of incorporation. Most states provide opportunity for shareholders that dissent to importance changes that would affect their rights and preferences to obtain the appraised value of their shares in cash.

o nondelegable board responsibilities – the BoD cannot delegate to a committee matters including initiating amendments to the certificate of incorporation or adopting an agreement of merger or consolidation; transactions “outside the normal course of business” are also non-delegable.

o disclosure requirements – constrain management of corporations in significant ways: contracts between a corporation and one/more of its directors may be void/voidable unless proper advance disclosure is made to the corporation. The scope of areas in which disclosure is required has been expanding. Currently includes notice of all meetings of shareholders (if special meeting must include purpose); annual franchise tax reports, etc. “These requirements, along with the other filing and notice obligations… are intended to insure that the shareholders, and in certain instances the state of incorporation, are aware of actions taken or proposed to be taken by the corporation.”

Recent Procedural Trends: historically only the law of the state of incorporation has been important, however, a flexible “choice of law” principle has started to emerge that permits “host” states to apply their laws to internal corporate disputes when the state has a significant interest in the corporate (e.g. significant # of shareholders reside in host state).

Duties of Loyalty, Care, and Fairness: In NY there is a statutory test of “good faith and that degree of diligence, care and skill which would ordinarily prudent men would exercise under similar circumstances in like positions.” In Delaware, there is no statutory test, but use standard of good faith and reasonable belief in best interest of the corporation. In addition to any statutory requirements, directors are subject to COL duties of loyalty and due care. Loyalty means no personal gain by director, either through taking personal advantage of a business opportunity resulting from his


relationship with the corporation or by doing business deals with the corporation. Care means going to meetings, and making sure that there is a good faith basis for relying on the books/counsel/records of the corporation.

The “Corporate Opportunity” Doctrine: is part of the fiduciary duty of directors. It is a conflict-of-interest rule that provides that “an officer or director of a corporation may not acquire for personal profit a business opportunity which rightfully belongs to the corporation.”

The “Business Judgement Rule”: was developed to distinguish which actions of directors should be subject to judicial challenge and which should be protected. Based on the principle that unless directors acted in bad faith, their business judgements should not be displaced by shareholders/judges. Recent case law indicates that unreasonable decisions will not be protected by this rule, even if the Board acted in good faith. There has been a recent trend in suits seeking the creation of new liabilities for directors.

FEDERAL LAW – Regulatory approach: federal securities laws have played an expanding role in the increasing ambit of management’s fiduciary duties. Federal disclosure requirements are central to this, and are based on the idea that this will protect investors by allowing them to make informed choices.

Corporate governance: there have been many recent proposals to reduce the role of management and increase the role of shareholders and directors. Securities laws and regulations are important to this – specifically rules created relating to organic changes in the corporation, disclosure rules, and proxy rules.

Romano, Roberta The Genius of American Corporate Law, 6 (1993) The AEI Press, Washington, D.C., 118***note: after reading this article, I was a little confused as to why Janda went on at such great length about her system… there is a lot of fluff, which we didn’t discuss in class. >> State competition for corporate charters is unique to the US. Although CAN has a federal system, an active market for corporate charters has not developed. Similarly the Treaty of Rome envisions a federal system for the EU, but it has not fostered corporate charter competition among EC members.Production of Corporate Law in Canada is there state competition for charters to begin with? Two theorists, DANIELS and MacINTOSH,

disagree about this. Daniels thinks the CBCA provoked competition among provinces, in a manner similar to the US; MacIntosh thinks that the diffusion of the CBCA across CAN results either from administrators with strong preferences for uniform laws or consensus on what constitutes a good law.

DANIELS thinks that the role of CAN gov’t is analogous to Delaware: predominant choice for firms when reincorporating is nat’l & is also popular choice for first incorporation, esp from Quebec. Daniels relates this last point to the separatist movement and the incorporation fee structure. When national incorporation fees were increased in 1985, the incidence of original incorporation from Q dropped. No big separatist worries at that point, so price became a more compelling reason to chose jurisdiction. Thinks that fee increase in 1985 resulted from lobbying by Q politicians, who wanted a greater market share of incorporations.

Romano notes that Daniels doesn’t comment on why the nat’l gov’t might have agreed to this. Thinks this is actually more consistent with MacIntosh, and theory that nat’l gov’t was not seriously competing for charters. OR, nat’l gov’t might have thought that they offered a sufficiently superior product and that businesses would be willing to pay a premium, as they do for Delaware incorporation. But when this didn’t prove true they didn’t drop the price, so unpersuasive. Alternately, nat’l gov’t may have stopped competing when it decided to raise incorporation fees, in return for Quebec support on policy issues unrelated to corporate law.

generally, national governments do not have the same kind of incentive to compete for corporate charters, since the amount of their total revenue that this source of income represents is miniscule. Therefore, there is a minimal fiscal penalty for failing to innovate, or to be responsive to firms.


“The decrease in national incorporations after the fee increase is, then, not simply a function of sensitivity of firms to charter prices. Rather, it is a function of price and an additional factor, the government’s reputation for responsiveness… firms perceived the government’s fee increase as an indication that it would also capitulate to provincial pressure concerning substantive code content. As a consequence, national incorporations declined as firms realized it was too costly to run the risk of a national domicile.”(p.36)

state competition is less effective in CAN than in the US because several factors important to Delaware’s success are lacking: 1) comprehensive and specialized corporate jurisprudence; 2) lack of significant dependence on franchise revenues; 3) provinces do not control their corporation codes (authority shared with independent provincial

regulators and national judges); 4) securities regulators have jurisdiction based on residence of investor rather than domicile of

corporation (can override provincial corporate law regimes – this is opposite of US where Supreme Court has refused to expand securities law for this purpose);

5) SCC reviews all provincial appellate courts (though after automatic right of appeal for cases over 10K$ removed in 1974 fewer cases make it to SCC, this still contrasts with US where US SC has little basis to review a Delaware court’s corporate law decision);

6) all Canadian judges are federal appointees with life tenure, which reduced a judge’s incentive to be responsive to changing business conditions.

“A province’s control over what is ostensibly its substantive law and the judges who interpret that law is, then, highly circumscribed. … The inability of provinces to commit credibly to a responsive corporate law regime, given overlapping jurisdiction, also renders firms less willing to invest in optimizing incorporation decisions, which has a feedback effect, further reducing provincial incentives to compete.”

differences in stock ownership – large CAN corp. have a higher concentration of stock ownership than US counterparts. The increase in ownership concentration means that it is less important what jurisdiction the firm is incorporated in, as the majority shareholders have enough votes to change statutory default rules anyways. [Romano notes that there is insufficient data to determine a causal relationship between concentration of ownership and charter competition.]

differences in patterns of shareholder litigation – much easier in the US than in CAN: US cost rules are more favourable to shareholders; there is a greater reliance of contingency fees for lawyers; and class action suits are more restrictive than in the US. In CAN, greater concentration of ownership may reduce need for litigation as controlling shareholders will have greater incentive to be monitoring management. Also, if provinces are not competing for charters to start with, that would also explain why there isn’t competition on this dimension.

Production of Corporate Law in the EU treaty not into strong central government, but does aim to harmonize corp laws across EU most EUR states take enterprise approach to the corp, which requires that employees (EE) as well

as shareholders must be involved in decision-making. Maximization of share value is unlikely to be the main objective of corporations operating under this model. In the US, provisions permit directors to consider EE interests in decisions regarding control changes but are not required to do so. EE in US have no right to enforce provisions, and no rights to representation. (Side note: some firms, esp German ones, fund pensions through accumulated positive balances rather than investing in securities as they do in the US – this may give EE a greater right to participate.)

“Nations pursuing mixed objectives in corporation codes cannot compete effectively for corporate charters… against states whose codes focus on shareholders: stock values of firms incorporated in the former nations will be lower than those in the latter, where firms will prefer to locate…. To preserve multiple objective codes, nations will therefore seek to prevent the emergence of an active charter competition: the absence of competition ensures the viability of their corporation laws.” (p. 42)

other legal and institutional barriers to active EUR charter market:


1) most EUR nations follow the “real seat” rule rather than the “statutory domicile” rule. Reincorporation is much more expensive under the real seat rule, because the company must be physically relocated to reincorporate. Reincorporation is also more expensive in the EU because it is treated as liquidation, not a transfer, and so any hidden reserves (e.g. asset appreciation) are taxed.

2) most EUR do not have annual franchise taxes so incorporations do not generate an annual source of income

3) more difficult for shareholders to sue directors/officers than in US/CAN (derivative actions not allowed, fiduciary duties not developed) – “without steady stream of lawsuits creating precedents to interpret code provisions, the attractiveness of a jurisdiction as a corporate domicile is diminished.” (43)

4) EUR markets are undercapitalized compared to US – in EUR much corporate capital is raised through banks (can’t determine causality)

5) Many EUR companies are not publicly traded. it seems that rather than competition for corporate charters, the competition in EU is over choice of

business form. Businesses will often choose to be a limited liability corporation to avoid the higher taxes, more extensive worker participation, and other rigid legal requirements associated with incorporation.

Is there a Relation Between Productivity and Corporate Governance? In recent years a number of nations with different forms of corporate governance have surpassed the US on a variety of productivity growth measures. Although there are no empirical studies showing that corporate governance arrangements affect productivity, some think that perhaps the US should change its position to resemble other nations. Romano doesn’t buy it. Thinks it is part of the inevitable catch-up following incredible post-WWII

production in US. last paragraph of article was on Janda slide: “A more useful way to characterize the connection

between politics and economic organizational form, particularly in the contractual context of business organization, is to recognize that private parties are persistent in devising institutions that circumvent or minimize the effect of political constraints on economic development. The genius of American corporate law in this regard is that the dynamics of state competition reduces the number of extraneous regulations that must be bypassed.”

PART 2: THE THEORY OF THE FIRM: WHY FIRMS, WHY CORPORATIONS AND WHY SEPARATION OF OWNERSHIP AND CONTROL?

Parallel VanDuzer Readings: Chapter 3 Part G, Chapters 1 & 2.

January 18, Class 4: Why are there firms rather than a web of individual contracts? Nobel Laureate Ronald Coase’s classic work on the nature of the corporation proposes a widely accepted transaction cost model to explain the nature of the firm.

Coase, R.H. "The Nature of the Firm" in The Firm the Market and the Law, 2 (1998) The University of Chicago Press, 33 Economic theory has suffered from its failure to state its assumptions. Economists have often omitted

the foundations on which their theories are erected. Such an examination is necessary to prevent the misunderstanding and controversy which arise from a lack of knowledge of the assumptions on which a theory is based and because of the importance for economics of good judgment to choose between rival sets of assumptions.

Since there is an apparent trend in economic theory towards starting analysis with the individual firm


and not with the industry, it is necessary to give a clear definition of “firm” and that its difference from a firm in the “real world,” if there is one, should be made clear.

Coase hopes to show that a definition of a firm may be obtained which is not only realistic in that it corresponds to what is meant by a firm in the real world, but is tractable by two powerful instruments of economic analysis (developed by Marshall), the idea of the margin and that of substitution.

He first considers the economic system as it is normally treated by the economist. An economist thinks of the economic system as being co-ordinated by the price mechanism, and society becomes not an organization but an organism. This theory assumes that the direction of resources is dependent directly on the price mechanism. But this picture is incomplete.

Outside the firm, price movements direct production, which is co-ordinated through a series of exchange transactions on the market. Within a firm, these market transactions are eliminated and the entrepreneur-co-ordinator, who directs production, is substituted.

The degree to which the price mechanism is superseded varies greatly. In a department store, the allocation of the different sections to the various locations in the building may be done by the controlling authority or it may be the result of competitive price bidding for space. The amount of vertical integration varies greatly from industry to industry and from firm to firm.

The distinguishing mark of the firm is the supersession of the price mechanism. It is related to an outside network of relative prices and costs, but it is important to discover the exact nature of this relationship.

Coase’s purpose is to bridge what appears to be a gap in economic theory between the assumption that resources are allocated by means of the price mechanism and the assumption that this allocation is dependent on the entrepreneur-co-ordinator. The basis on which this choice between alternatives is effected needs to be explained.

His purpose is to discover why a firm emerges at all in a specialized exchange economy. The main reason why it is profitable to establish a firm would seem to be that there is a cost of using

the price mechanism. The most obvious cost of organizing production through the price mechanism is that of discovering what the relevant prices are. The cost maybe reduced but not eliminated. The costs of negotiating and concluding a separate contract for each exchange transaction on the market must also be taken into account. It is true that contracts are not eliminated when there is a firm but they are greatly reduced. The essence of the contract is that it should state the limits and powers of the entrepreneur, within which, he can direct the other factors of production.

There are disadvantages or costs of using price mechanism. It may be desired to make a long-term contract for the supply of some article or service. The longer the contract is for the supply of the commodity or service, the less possible it is for the person purchasing what the other contracting party is expected to do. A firm is likely to emerge where a short-term contract would be unsatisfactory.

The operation of a market costs something and by forming an organization and allowing some authority to direct the resources, certain marketing costs can be saved.

The question of uncertainty is also relevant to the study of the equilibrium of the firm and it seems improbable that a firm would emerge without the existence of uncertainty.

Another notable factor is that exchange transactions on the market and the same transactions within a firm are often treated differently by governments or other regulatory powers (e.g. sales tax, quota schemes). However, it is difficult to imagine that measures such as these have actually brought firms into existence. A firm consists of the system of relationships which comes into existence when the direction of resources is dependent on an entrepreneur.

A firm becomes larger as additional transactions are organized by the entrepreneur and smaller as he abandons the organization of such transactions. The question then is whether it is possible to study the forces which determine the size of the firm. Knight considers it impossible to treat the determinants of the size of the firm, but Coase will attempt it.

It was suggested that the introduction of the firm was due to the existence of marketing costs. Coase asks: why if by organizing one can eliminate certain costs and in fact reduce the cost of production


are there any market transactions at all? He says there are a few possible explanations:

1. As the firm gets larger, there may be decreasing returns to the entrepreneur function and the costs of organizing more transactions may rise.

2. As organized transactions increase, the entrepreneur fails to place the factors of production in the uses where their value is greatest, that is, fails to make the best use of factors of production.

3. The supply price of one or more of the factors of production may rise because the other advantages of a small firm are greater than those of a large firm.

The first two reasons correspond to the economist’s phrase “diminishing returns to management.” A firm will tend to be larger:

(a) the less the costs of organizing and the slower these costs rise with an increase in the transactions organized;

(b) the less likely the entrepreneur is to make mistakes and the smaller the increase in mistakes with an increase in the transactions organized;

(c) the greater the lowering in the supply price of factors of production to firms of larger size. The costs of organizing and the losses through mistakes will increase in the spatial distribution of the

transactions organized, in the dissimilarity of transactions, and in the probability of changes in relevant prices. This suggests that efficiency will tend to decrease as the firm gets larger. All changes which improve managerial technique will tend to increase the size of the firm.

The definition of firm used above can give meaning to the terms “combination” and “integration.” There is a combination when transactions previously organized by two or more entrepreneurs become organized by one. This becomes integration when it involves the organization of transactions which were previously carried out among the entrepreneurs on a market. A firm can expand in either or both of these two ways.

Dobb puts forth the view that the reason for the existence of a firm is to be found in the division of labour, as a result of an increasing complexity of the division of labour. The growth creates the need for some integrating force. But Coase’s answer is that the integrating force already exists in the form of the price mechanism. What has to be explained is why one integrating force (entrepreneur) should be substituted for another (price mechanism).

Coase then goes into in-depth discussion of Knight’s work. The most relevant thing was the discussion of uncertainty: the fact of uncertainty means that people have to forecast future wants. So you get a special class who directs the activities of others to whom it gives guaranteed wages.

It has sometimes been assumed that a firm is limited in size under perfect competition if its cost curve slopes upward, while under imperfect competition it is limited in size because it will not pay to produce more than the output at which marginal cost is equal to marginal revenue. But firms may produce more than one product, so there is no reason why this upward slope of the cost curve in the case of perfect competition or the fact that marginal cost will not always be below marginal revenue in the case of imperfect competition should limit the size of the firm.

To determine the size of the firm, we have to consider the marketing costs (costs of using the price mechanism) and the costs of organizing of different entrepreneurs, and then we can determine how many products will be produced by each firm and how much of each it will produce.

It is best to approach the question of what constitutes a firm in practice by considering the legal relationship normally called that of “master and servant” or “employer and employee.” The essentials of this relationship are: the servant must be under the duty of rendering personal services to master; the master must have the right to control the servant’s work.

When we are considering how large a firm will be, the principle of marginalism works smoothly. The question always is whether it pays to bring an extra exchange transaction under the organizing authority.

Business men will constantly be experimenting, controlling more or less. Dynamic factors are of importance and examining the effect changes have on the cost of organizing within the firm and on marketing costs will explain why firms get larger and smaller. We thus have a theory of moving


equilibrium.

January 20, Class 5: What are the different legal forms of business association?This reading presents a somewhat technical account of the sole ownership, partnership and incorporation and paves the way for a discussion of legal personality of the corporation, which is the focus of the next section of the course.

See also VanDuzer Chapter 1, Part C.

Klein, William A. and Coffee, John C. Jr. Business Organization and Finance – Legal and Economic Principles, (1993) Westbury, New York, 5, 51Objective: understand the nature and functions of business organizationsSole Proprietorship (SP)Ownership and management: owner can hire a manager – so SPs can get sophisticatedNature of Ownership Interest: in law, what owner owns for the store is same as what owner owns for personal purposes (e.g. clothes)Liability for Debts: Open Accounts (= trade account, i.e. account with a supplier) are personal obligation of the owner; owner has unlimited liabilityNonrecourse loan: method of avoiding liability for business debts; make a loan secured by a specific property, and have lender agree that in the event of nonpayment, its sole recourse would be to sell that property.Personal Debt: if owner fails to repay a personal debt, the personal creditor can go after her business assetsDebt and Equity: (value of business) – (amount of debt) = owner’s equity in the business. There’s often a difference between “book value” of equity and debt and “market value” e.g. say owner gets a $100 loan. If, after getting the loan, business takes a turn for the worse so probability of repayment decreases, market value decreases (e.g. no investor would buy the note from the bank for the full $100), but book value will always be $100.Leverage: describes the financial consequences of the use of debt and equity. The use of debt created financial leverage for the equity. The greater the debt, the greater the leverage. The greater the leverage the greater the potential gains and losses for the equity and the greater the risk of loss for the debt. This is because (a) lender has a fixed claim (for, say $100); (b) the return on the investment or business financed by the debt is uncertain; and (c) the borrower has a residual claim (i.e. gets everything after pays off the lender’s fixed claim).PartnershipsJoint ownershipTend to be larger than sole proprietorships, but still on a relatively small scaleLaw of partnerships (generally default rules, so can be changed by express agreement) tends to assume a small scale, that the partners have personal relationships e.g. power of partners to bind the partnership, personal liability, duration and continuity; even in big law or accounting partnerships, partners must rely on one anotherCan have partnership of two or more corporations often, decision whether to incorporate or not is motivated by tax considerationsReasons for Joint Ownership:The Need to Assemble at-risk capital: say the owner needs $100 to get going and buy a physical space. Lenders don’t want to lend the whole amount, because they want to get paid, so want to know that if they seize the property they’ll get their money back. Or they’ll lend the whole amount but at a really high interest rate to compensate. If they’re joint owners, they will take a share of the profits (higher risk, but also potentially much higher returns), i.e. a residual or equity interest. (as opposed to a fixed interest)


Control Follows Risk: It’s natural that, if one is sharing in risks and returns that one would want to have some control too. If not, there would be created a situation of “moral hazard”: the owner with control can take gambles that are risking largely other people’s investment.SummaryCapital can be contributed to firms in the form of equity (by owners) or debt (by lenders). Equity is the residual claim. As the amount of debt increases in relation to equity, the interest rate will increase (increased risk). Lenders who don’t want this high risk will therefore insist on a large enough amount of equity that they feel secure against risk of default. This may be too much for one person, so two or more equity investors will have to pool their resources and become joint owners.

January 25, Class 6: What is the Business Trust?Given the rise of the Business Trust, this class will be devoted to a discussion of its nature and implications. The readings are a supplement to the materials and will be on the web site.

January 27, Class 7: What is the relationship between ownership and control in business associations?Berle and Means present the classic thesis that the modern corporation is characterized by a problematic separation between ownership and control. Chandler explores the nature of managerial hierarchies within the firm and sociologist Pierre Bourdieu characterizes the firm as a semi-autonomous social field.

Berle, Adolf A. and Means, Gardiner C. The Modern Corporation and Private Property, 1-4 (1967) Harcourt, Brace & World, Inc., New York, 293Chapter I: The Traditional Logic of Property -Traditionally, profits go to owners (shareholders) but since it is clear that managers can divert profits to their own ends, it is no longer certain that this model works. Society must figure out how to deal with this. The common law (using historical arguments about property owners’ full use and entitlement of their property) dictates that all profits from corporations should go to the shareholders. Although the stockholder does not have legal title to the assets of the corporation, this paradigm still dictates that the corporation is “theirs, to be operated for their benefit.” powers delegated to management are not absolute, but rather held in trust: “The controlling group is

… managing and controlling a corporation for the benefit of the owners.” Furthermore, in light of COL any grants of power made to non-owners are for the purpose of improving the operation of the corporation for the benefit of the owners: “Despite [any] situations in which the controlling group is able, first, to seize a portion of the corporate profits and, second, to hold them against attack, the theory of the law seems clear. All powers granted to management and control are powers in trust.” This theory originates in the doctrine of equity, which dictates that non-owning managers must be fiduciaries.

In modern corporations, the two attributes of business ownership (risking of previously collected wealth and managing of actual business) were always joined. In modern corporations, “one traditional attribute of ownership is attached to stock ownership; the other attribute is attached to corporate control.”

to determine whether this change in ownership/control mandates a change in division of profits requires one to look outside of law and into the social and economic background of law.

Chapter II: The Traditional Logic of Profits - in economic terms, the good arising from the protection of property is theoretically linked to the efforts expended to acquire wealth, rather than the inalienable rights of property. The traditional logic of profits states that “in seeking profits, the individual would, perhaps unconsciously, satisfy the wants of others.” this is based on old ideas about encouraging individual enterprise for the good of all. Profits are seen

as a reward for risking wealth, & as the inventive to use all skill in making enterprise profitable. This may have been more appropriate in the past when industry was primarily carried out by many

small private enterprises, in modern corporations risk/control are performed by 2 different groups.


If profits can be made more than sufficient to satisfy those fronting the money, why shouldn’t some of it go to those who are in control? Giving extra profits to those risking wealth serves no useful economic function. If those in control do not have inducement to manage the business efficiently, there won’t be so much profit anyways.

“The traditional logic of profits, when thus applied to the modern corporation, would indicate that if profits must be distributed either to the owners or to control, only a fair return on capital should be distributed to the "owners" while the remainder should go to the control as an inducement to the most efficient ultimate management. The corporation would thus be operated financially in the interests of control, the stockholders becoming merely the recipients of wages of capital. This conclusion runs directly counter to the conclusion reached by applying the traditional logic of property to precisely the same situation and is equally suspect.” (76)

Chapter III: The Inadequacy of Traditional Theory – Not only are the terms used by 19th C economists (Adam Smith) are no longer accurate, they are actually misleading when applied to modern corporations. Smith himself recognized this would be the case (see diatribe p. 77). private property: passive property – relationship between individual and enterprise in which

individual has rights, but almost no power; active property – individuals have powers over, but almost no rights in the enterprise. Also have almost no duties which can be enforced effectively.

if both active and passive property attach to same individual or group, then have private property as conceptualized by older economists; otherwise must consider them separately.

wealth: for holders of private property, wealth is a bundle of expectations that have a market value (may bring income/ may be sold in the market for other forms of wealth). For holders of active property, wealth is not tangible and cannot be separated from continued functioning of business organization. These two kinds of wealth are fundamentally different.

private enterprise: the old definition is so unrelated from the modern corporation that it is useless, and must be replaced by the notion of “corporate enterprise”.

individual initiative: in a large modern enterprise, individual liberty is necessarily curbed – must cooperate, unless are at top pf hierarchical power structure.

profit motive: because of the splitting of roles described above, only effective in rewarding control when diverted from “owners”.

competition: the scale of corporations now mean that costs are no longer determinate and competition is no longer an effective regulator.

Chapter IV: The New Concept of the Corporation – “The depersonalization of ownership simultaneously implies the objectification of the thing owned. The claims to ownership are subdivided in such a fashion, and are so mobile, that the enterprise assumes an independent life, as if it belonged to no one; it takes an objective existence, such as in earlier days was embodied only in church and state, … The depersonalization of ownership, the objectification of enterprise, the detachment of property from the possessor, leads to a point where the enterprise becomes transformed into an institution which resembles the state in character.” (79) [must therefore be analyzed in terms of social organization…] “ A constant warfare has existed between individuals wielding power, in whatever form, and the

subjects of that power… Absolute power is useful in building the organization. More slow, but equally sure is the development of social pressure demanding that the power shall be used for the benefit of all concerned. This pressure, constant in ecclesiastical and political history, is already making its appearance in many guises in the economic field.” (80)

as corporations grow in strength, power will be concentrated in a few hands and there will be increasing demands for responsible power. To make these demands effective, consider three possibilities:1) apply traditional property law to owners of passive property (results in businesses being run by

trustees)2) since managers have acquired active property rights on quasi-contractual basis, consider that

security holders have agreed in advance to any losses which they may suffer as a result.


3) consider that by surrendering active property rights, those with passive property rights have released community from protecting their property rights in traditional way. But can’t say that those with active property rights therefore automatically should benefit – rather, they have “cleared the way for the claims of a group far wider than either the owners or the control. They have placed the community in a position to demand that the modern corporation serve not alone the owners or the control, but all society… Neither the claims of ownership nor those of control can stand against the paramount interests of the community. … When a convincing system of community obligations is worked out and is generally accepted, in that moment the passive property rights of today must yield before the larger interests of society.”

“The modern corporation may be regarded not simply as one form of social organization but potentially (if not yet actually) as the dominant institution of the modern world… The future may see the economic organism, now typified by the corporation, not only on an equal plane with the state, but possibly even superseding it as the dominant form of social organization. The law of corporations, accordingly, might well be considered as a potential constitutional law for the new economic state, while business practice is increasingly assuming the aspect of economic statesmanship.” (81)

Chandler, A.D. Jr. "Managerial Hierarchies", Organization Theory – Selected Readings, ed. by Major sectors of technologically advanced market economies have come to be dominated by big

business. Managers are responsible for coordinating the day-to-day flow of goods and for allocating resources. The visible hand of managerial direction has replaced the invisible hand of marketing mechanisms in coordinating flows and allocating resources.

Chandler’s purpose is to describe and attempt to explain why, when, and how this fundamental transformation occurred.

Manager enterprise and managerial capitalism Two major characteristics define modern business enterprise:

1. It contains many distinct operating units and its own set of books and accounts that can be audited separately from those of the larger enterprise.

2. It employs a hierarchy of middle and top salaried managers who supervise the work of the units under its control and who form a new class of businesspeople.

This two part definition suggests a basic hypothesis: the modern business enterprise began and expanded by internalizing activities and transactions previously carried out by a number of separate businesses.

This emerged when businesses could be operated more profitably through a centralized managerial hierarchy than by means of a decentralized market mechanisms.

Once a managerial hierarchy successfully increased profits by coordinating operations it became itself a source of power. As managers’ roles became more specialized, they became increasingly independent of the owners of the enterprises.

The multiunit enterprise emerged and changed the nature of capitalism. In traditional, personal capitalism, owners and decision-makers were the same. In large, multiunit enterprises, salaried middle managers who have little or no share in its ownership are responsible for day-to-day operations and owners rarely concern themselves with the work of middle management.

The first type of modern business enterprise is the entrepreneurial or family firm; the second is financially dominated form. Family and financial capitalism were transitional stages in the evolution of the modern enterprise. No family or financial institution was large enough to staff the managerial hierarchies for multiunit enterprises. Salaried managers developed specialized knowledge and they took over top-level decision-making.

Managerial capitalism now dominates producing and distributing sectors in every major market economy.


The rise of the modern enterprise in the United States**Note: the next few sections gave an exhaustive account of the rise of the modern enterprises in the States so I tried to distil only the essentials. Before the arrival of the railroad and telegraph, business activity in the U.S. economy was not

extensive enough to create a need for multiunit enterprises or for salaried managers. As businesses became more numerous, they became more specialized. The activities of these small

businesses were coordinated almost entirely by the invisible hand of market mechanisms. Once new technologies developed, making possible greater speed and volume, managerial hierarchies

became necessary to supervise and coordinate the new processes of production and distribution. In sectors dominated by the new, large enterprises, the top-level managers of a few multiunit

companies made the decision previously made by thousands of small firms.

Transportation and communications First modern business enterprises, such as railroad and telegraph companies, appeared in 1850s. Railroads required centralized operating control and managerial hierarchies first appeared when

railroads began to operate more miles of track tan could be personally managed by a few individuals. The effective operation of the larger railroad networks required external cooperation among

managerial hierarchies. Once the cooperative techniques were perfected, railroad companies internalized most of the activities that had been undertaken by express companies, freight forwarders, etc.

But comparable cooperation among managerial hierarchies to control competition among railroads was less successful. To prevent competition, railroads formed federations, which allocated traffic and profits.

Managers decided to enlarge their enterprises by constructing new lines or buying existing ones. The operation of these railroad systems required the creation of two or three levels of middle management.

Other transportation and communications enterprises followed suit. By the beginning of the 20th century, the nation’s transportation and communications were operated

by large, modern, multiunit enterprises administered by salaried managers.

Distribution By 1880s, a revolution occurred in commerce. Wholesalers gave way to new mass retailers, like

department stores that sold directly to the consumer, the mailorder houses, and chain stores. Each of these new distributors was similarly organized. Each had extensive buying and selling

organization. Profit came from volume rather than mark-up. Success was achieved through ‘stock-turn’ or how many times stock turned over within a period of time. Thus, the visible hand of management came to coordinate the low of goods from producers to retailers or consumers in a more efficient and profitable manner than had been achieved through market mechanisms.

Mass retailers began to take over business from wholesalers and the retailers grew rapidly by adding new lines of products. The success was dramatic and wholesalers and small retailers turned to politics to obtain state and federal regulations to protect themselves.

Many of these enterprises continued to be owner and controlled by the founders and their families, so the distribution sector remained a bastion of family capitalism longer than any other.

Production The revolution here took loner because more technological development was required. Three basic mass-production techniques – large-batch and continuous-process production methods

and those involving the making of machinery – were quickly perfected. These techniques appeared first in refining and distilling industries.

Mass production came more slowly in metal-making and metal-working industries. The new methods of mass production did not in themselves lead to the creation of multiunit


enterprises; the new mass producers only became modern enterprises when they integrated forward by creating their own extensive organizations for sales and distribution.

The integrated industrial enterprise In the 1880s, enterprises that integrated mass production with mass distribution appeared suddenly in

many industries, but clustered in four types of industries: low-priced, semiperishable, packaged products; processors of perishable products for national markets; manufacturers of new mass-produced machines; and makers of high-volume producer goods.

For the new firms that integrated high-volume production with national and international distribution, administrative coordination went beyond what had been done in other industries. It meant the provision of specialized services and facilities and adjustment of product to suit customer needs.

The limits to effective administrative coordination were directly related to scheduling and marketing needs.

Building the purchasing and marketing organizations that were essential to mass producing and distributing created powerful barriers to entry by other firms. Thus, these industries came to be dominated by a few large integrated firms that competed against each other in an oligopolistic manner.

Growth through mergers In the 1880s, a number of small, single-unit manufacturing enterprises managed personally by their

owners merged into a single entity, legally defined as a trust or holding company. In the 1890s, mergers became more popular. The number of firms and the problem of legally

enforcing agreements among them made cartels difficult to maintain. Then the Sherman Antitrust Act was passed in 1890 and New Jersey’s general incorporation law in 1889. The first was a federal law, declaring illegal and trust association or other combination in restraint of trade, while the second permitted a company formed to hold stock in another to receive a charter simply by filing a form and paying a fee.

Few mergers continued to prosper unless two conditions were met: it replaced a strategy of horizontal combination with one of vertical integration and it created a managerial hierarchy to coordinate, monitor, and allocate resources through its operating units.

Expanding the managerial enterprise The relationship between ownership and control in large, integrated mass-production firms depended

on the route by which the enterprise expanded. Those that became multiunit enterprises by creating an extensive marketing and purchasing organization almost always built their facilities with capital from retained earnings. Ownership remained in the family members, who continued to share in decision-making. Industrial enterprises that grew through mergers quickly became dominated by managers.

After WWI, majority of enterprises came to be controlled by managers partly due to passage of time. Members of founding families continued in decision-making only if they had extensive managerial training. Financiers also had a declining role in decision-making.

The continued growth of enterprises also increased the power of managers. Managers planned the growth, increasing the number of executives at all managerial levels.

As integrated industrial enterprises grew and diversified their activities, managers became increasingly professional in training and outlook. Soon Harvard, Dartmouth, and others began to offer courses on business administration to train managers.

By the mid-20th century, managerial enterprise had become the dominant business institution.

The rise of the managerial enterprise in Europe The modern multiunit industrial enterprise first appeared in Europe in the late 19 th century clustered

in few industries, with an increasing need for professional managers.


In Europe, families and financiers continued to make critical decisions, so the managerial class remained much smaller than in the U.S.

The government also played a larger role in the infrastructure and, as a result, administrative techniques and personnel were transferred directly to business from government.

The most important difference was that mass production was less often integrated with mass distribution in Europe. Thus, the integrated industrial firm had less chance to grow and diversify.

The U.S. became the seedbed of managerial capitalism because of size and nature of its domestic market, while in Europe the mass markets developed more slowly. The oversupply of labour and low wages reduced consumer demand and regional and class tastes differed more strongly.

Cultural and social factors also appear to have delayed the coming of the large managerial enterprise and managerial capitalism. In the U.S. individualistic values and the fear of concentrated economic power existed, while in Europe, family firms joined federations to ensure that profits would continue.

Class distinctions also played a role: families in Europe continued to dominate top-level management and often chose not to expand if it meant giving up persona control.

It now appears that managerial capitalism is becoming the dominant system in Europe. But clear differences remain in the ways in which the flow of goods through the economy are coordinated and resources allocated for future production and distribution.

D.S. Pugh 7 (1990) Penguin Books, UK, 95*** I don’t know what this is***

Bourdieu, Pierre Les structures sociales de l’économie, (2000) Éditions du Seuil, 252

Decisions regarding price and other areas are not dependent on one unique actor If you go into the “black box” that is the enterprise you find not people, but a structure We can discern tendencies of the evolution of relations between the major power-holders in the

corporation: the entrepreneur who masters new technologies and assembles the funds necessary to get the corporation off the ground; banks and financial institutions; managers, but we need to look at configuration of power on the enterprise

The ends of the enterprise are the stakes of the decision-makers. For rational calculations of an enlightened decision maker you have to substitute political

struggles between agents that tend to identify their specific interests (linked to their position in the enterprise) as the interests of the corporation and the power of whom is measures by their ability to make the interests of the corporation equivalent to their interest in the firm (for better or for worse)

True, there’s interaction between stakeholders in a corporation, but this must be subordinated to a structural analysis of the conditions that delimit the boundaries of possible strategies (i.e. the structure that delimits the boundaries of possible interactions)

In the economic field, one doesn’t have to have the intention to destroy (somebody else’s interest) to produce destructive effects

Economic orthodoxy is a sort of anthropological monster: the economist assumes the scholastic fallacy, assuming that those being studied is aware of and studies the considerations and theoretical constructions that he should have elaborated to come to the decisions they come to, based on maximizing utility

Annex: A case study (it’s really boring and doesn’t say anything new) A big corporation that produced cement that, because of a decision to delocalize part of its

services, was reorienting its financial and commercial approach. Different personnel had, depending on their position in the corporation, different perspectives


PART 3: THE EMERGENCE OF LEGAL PERSONALITY OF THE CORPORATION: COMPARATIVE HISTORY, JUSTIFICATION AND RELATION TO SOCIOECONOMIC FACT

Parallel VanDuzer Readings: Chapter 3 Parts C & H, Chapter 4 Parts B & D

February 1, Class 8: How do the emergence of and changes to the corporate form relate to changes in economic relationships?Harvard Law Dean Robert Clark’s oft-cited account of the four stages of capitalism is a useful backdrop not only to the theme of corporate personality but ultimately to the central problem of corporate governance which will be the main substantive theme of the course.

Clark, Robert Charles "The Four Stages of Capitalism: Reflections on Investment Management Treatises" (1981) 94 Harvard Law Review 561

The history of capitalism over the past 200 years can be organized into 4 distinct (but overlapping) stages. Each stage characterized by a distinct set of legal problems, to which the legal system has responded by employing regulatory strategies appropriate for that age.stage

(start) time

who/what legal/academic correlates regulatory strategies

1st 19th C “entrepreneur” invests, promotes, manages

rise of the corporation as a business organization

increased enactment of incorporation statutes

individual charters from the legislature

limits on powers and personality of corporation

anti-trust laws2nd early

20th C“professional business manager” appeared after split between ownership and control

modern publicly held corporation

development of stable relationships between professional managers and public investors (dual purpose to keep managers accountable, but also to give them full power)

enactment of federal securities law

development of modern concept of corporate law

affirmative disclosure requirements antifraud rules government control over immediate

market participants development by courts of fiduciary

duties conflict of interest rules

3rd 1960s “portfolio manager” decides how to invest others’ $$

characteristic institution is the institutional investor, or financial intermediary

“basic regulatory approach can be summed up in the concept of soundness. By a variety of methods, public suppliers of capital are insulated from the consequences of financial failure by intermediaries.”

4th 1980s “savings planner”

demonstrated by increasing predominance of group (as opposed to individual) life and health insurance policies; increasing use of EE pension

consumer protection: most importantly, disclosure requirements that inform the consumer of the terms of their participation and their particular


plans increased sharing of benefits,

decreased power of individuals to control investments.

expected benefits.

“As the second stage split entrepreneurship into ownership and control, and professionalized the latter, so the third stage split ownership into capital supplying and investment, and professionalized the investment function.” (109)

the proportion of saved $$ that is channelled through financial intermediaries has been increasing steadily through the 20th C and is now approx 80%.

the proportion of financial claims held directly by individuals has declined since WWII and the proportion held by financial intermediaries has increased (e.g. banks, insurance companies, pension plans, investment companies)

“As the third stage split the capital ownership function into the decision to supply capital funds and active investment management, and professionalized the latter, so the fourth stage seems intent upon splitting capital supplying into the possession of beneficial claims and the decision to save, and professionalizing the savings decision function.” (109-10).

most life/health insurance and pension plans contract out investment services the decision to save is only indirectly controlled by many of the workers who are to benefit from the

program at each stage there is “an increased division of labour, and increased participation in the fruits of

capitalist enterprise. Each later stage splits off and professionalizes a certain analytically distinct aspect of the capital mobilizing process, and creates a set of institutional arrangements that make it practical for a significantly greater proportion of the population to share in capital income… but this sharing … of the benefits of capitalist enterprise has been accompanied by an ever-greater concentration of important discretionary powers in the hands of professional managers and group representatives.” (111)

increase in division and concentration of discretionary power reflects the efficiency advantages of role specialization and the increasing degree of capital income reflects a general increase in wealth.

the last few pages are a review of two books dealing with the third stage – the details really don’t seem relevant, and were not discussed in class.

February 3, Class 9: What, in comparative perspective, are the historical underpinnings of corporate legal personality and limited liability? This rather elaborate set of readings should be approached with a light touch – feel free to skim. You are given here an overlapping and comparative set of historical accounts discussing the emergence of legal recognition for corporate legal personality and limited liability in civil law and common law jurisdictions.

Perrott, David L. "Changes in Attitude to Limited Liability – the European Experience", Limited Liability and the Corporation, ed. by Tony Orhnial, London & Canberra, 81 This paper seeks to demonstrate that concept of limited liability has not always seemed crucially

important to the corporate organization of business investment and risk taking. We are now entering a period of legal history that may be characterized by a retreat from limited liability.

Limited liability in relation to companies is usually taken to mean the principle whereby a member of a company cannot be made personally liable for the debts and other liabilities of the company beyond a certain amount. The member’s liability is limited by the shares that he holds in the company, the liability is normally limited to the difference between the amount already paid to the company on the share, and its fully-paid up value, plus any premium.

Perrott suggests that we are still living under a dominant ideology regarding limited liability that arose in 1860-1960, but that this ideology may be seen as a rather temporary phenomenon, especially


as there are now signs that we are beginning to move away into a new ideology that values limited liability less.

Main argument for limited liability are a public good are that it encourages investment in desirable but risky enterprises. Main argument against is based on concept of fairness to the company’s creditors, especially unsecured. Those who form and manage a company in such a way that it incurs liabilities beyond its resources should not be able to limit their own liability when outside creditors are empty handed.

Perrott’s three comments on these arguments:1. Argument for limited liability is economic, while argument against is moral. Thus these will be

affected by prevailing ideologies.2. Argument against applies with some force to management.3. Argument against loses some of its moral force if outside creditors are companies.

Limiting liability in Roman law From mid-republican times, there was a clear notion of limited liability in business transactions.

Under the Republic, most corporations seem to have arisen and been recognized spontaneously (free incorporation) and some were incorporated by governmental decree (concessionary incorporation).

The Romans also had a clear idea of corporate personality. Finally, the Roman notion of partnership (Societas), from which unlimited business associations was

derived, differed from common law or civil law forms. Liability to third parties was unlimited subject to contributions made, but no one partner was agent for the partnership, so contracts had to be made with all of the partners.

The Roman law of agency (Mandate) always retained the concept of personal liability of the agent, if he were a free man. A slave had no personal liability.

Although the Romans had well-developed concepts of limited liability and corporate personality they took no pains to relate the two together. Their concepts of partnership and agency were relatively undeveloped.

In England Guilds of artisans and tradesmen were established in Roman times, but in medieval England these

were not corporations at all, but more like social clubs. They gradually became more specialized and eventually they acquired the power to collect subscriptions, fines, and levies from members.

Initially guilds came to receive concessionary incorporation. The guild developed into the regulated company (regulated by Charter) and was not granted corporate personality and where some joint stock trading was anticipated, limited liability might be mentioned. Its purpose was to receive and operate a monopoly for its members.

In the guild merchant and regulated company, each member traded on his own account. But the social origins of the guild produced a form of limited liability, that is, it had a responsibility to assist wives and children of deceased members.

It was not invariable practice to grant limited liability and the Salmon v. Hamborough Co Case (1671) confirmed the principle that the liability of members of even a chartered corporation was unlimited unless their charter specified that it was limited.

On the continent

The compera This was a form of joint stock operation that rose to prominence in Northern Italy in late medieval

period. It originated as a way of raising a public loan at fixed interest but was eventually converted into genuine joint stock shareholders with limited liability. Didn’t catch on in rest of Italy.

The commenda


Its distinctive feature is a mixture of limited and unlimited liability imposed on different members. It became widely used all over continental Europe to finance overseas trade or other high risk enterprises.

The medieval societas and compagna This alternative type of partnership (societas or compagna) grew out of Roman societas and all

partners had unlimited liability for partnership debts. This was now coupled with a developed theory of agency, whereby each partner was regarded as the agent of all other partners for the purpose of binding the partnership to third parties.

The societe en comandite (Kommanditgesellschaft) The commenda form of partnership never took root in England. The English attempted to achieve

part of the commenda principle, the attraction of the form to the non-managing capital investor, by grafting the concept of the elaborate trust on the simple common law partnership.

England in the 18th century In this period, the device became popular of acquiring shares of a moribund corporation to acquire its

charter and then using the chartered powers for the envisaged new enterprise. This practice relied upon distorting the interpretation of the old charter to fit new circumstances for which it was never designed, with resulting legal uncertainties as to what was intra vires the corporation.

The unincorporated partnership was attractive because it could be formed at once without any necessity for governmental concession and that its founding deed could specify exactly what the purpose of the new enterprise, and the powers and liabilities of its officers and members were to be.

The Bubble Act 1720 Given the level of fraud, England was overdue for legislation controlling the excesses one hand and

protecting the tasks of honest company promoters, managers, and investors on the other. The Bubble Act: main aims were to restrain claims of any kind to corporate personality on the part of

unincorporated associations. Its effects were to increase the number of petitions for charters and the number of attempts to introduce private bills in parliament. Both procedures became slower and more costly, and promoters were driven back to common law partnership.

Only one prosecution was brought under the Act in that century.

England in the 19th century In the second prosecution, R. v. Dodd (1808), the relevant partnership trust deeds provided that ‘no

party could be accountable for more than the sum subscribed under the regulations therein stipulated.’ Lord Ellenborough referred to this hopeless attempt to provide limited liability without incorporation as a delusion. Limited liability in this time was not seen as desirable or undesirable, merely as technically unobtainable, outside formal incorporation by charter or act of parliament.

The Bubble Act was eventually repealed. Section 2 of the Repeal Act attempted to deal with limited liability by giving more power to the Crown to grant charters of incorporation.

The Limited Liability Act 1855 coupled limited liability obtained by agreement of the members with free incorporation for the first time.

In Salomon v. Salomon (1897), the House of Lords refused to remove the limit on Salomon’s liability for debts owed to outside unsecured creditors by the insolvent company of which he was sole proprietor and manager. The House, in choosing not to interfere with principles of limited liability and corporate personality, allowed economic ideology to triumph over moral argument.

The 20th century in France and Germany

France


Societe: must be formed for the purposes of profit-making (not so for association). The SCA, SA, and Sarl are always commercial companies and subject to rules of commercial and

civil codes. All societies are regarded as having a corporate personality distinct from their members. SCA and SA are societes de capitaux, so the identity of the investing members is irrelevant provided

that due capital is provided. The other forms are societes de personnes, where the members’ personalities are important to the business operation.

Societe en nom collectif: simple partnership with unlimited liability, corresponding to Roman societas.

Societe en commandite simple: partially limited partnership, with mixed limited and unlimited liability, from Italian commenda.

Societe en commandite par action (SCA): a limited partnership with mixed liability but also with transferable shares for the limited partners.

Societe anonyme (SA): true public company with limited liability and freely transferable shares. Societe responsibilite (Sarl): private company with limited liability.

Germany Variety of forms follows French system, but Germans have shown more ingenuity for reasons of tax

avoidance, producing hybrids, and combinations of existing forms. Gesellschaft des burgerlichen Rechts (GbR): simple partnership with unlimited liability. Offene Handelsgesellschaft (OHE): simple partnership with unlimited liability, restricted to purely

commercial enterprises and regulated by commercial code, has some corporate personality. Kommanditgesellschaft (KG): limited partnership with mixed liability (like societe en commandite

simple). Kommanditgesellschaft auf Aktien (KGaA): same as above with transferable shares (like en

commandite). Stille Gesellschaft (SG): silent or dormant partnership with mixed liability, where silent partner is

effectively a mere external loan creditor of a partnership business. Aktiengesellschaft (AG): public company (like French SA). Gesellschaft mit beschrankter Haftung (GmbH): private company (like Sarl).

The 20th century in England Apart from forms already mentioned, English law also recognizes the company limited by guarantee.

English law provides the flexibility whereby investors and promoters can obtain the advantages of free incorporation without limiting their liability to the nominal value of shares. The unlimited company has actually increased in recent years.

The future – a retreat from limited liability Certain developments in the commercial world seem to justify a prediction of further erosions of the

limited liability principle:(a) The rise in numbers, individual size, and market power of enterprises has produced a

countervailing demand for more efficient legal means of control of the activities of such undertakings, particularly ensuring that the management and ownership of a group be made more accountable for the activities of subsidiaries.

(b) Creation of European Economic Community, which constitutes an organization of devastating legal novelty.

(c) The fact that many have seen this kind of supranational legal power as the only effective antidote to the rise of multinationals.

Ouchi, William G. "Markets, Bureaucracies and Clans", Limited Liability and the Corporation, ed. by Tony Orhnial,


London & Canberra, 2051. The Nature of OrganizationsWhy do organizations exist? Coase: because it can mediate economic transactions between its members at lower cost that a market mechanism can.2. Markets, Bureaucracies and ClansThe problem of cooperation: any collectivity which has an economic goal must find means to control diverse individuals efficiently, who have only partially overlapping goals.Author’s interest: the efficiency with which transactions are carried out between individuals who are engaged in cooperative action.Cooperative action necessarily involves interdependence transactionsIndividuals must regard the transaction as equitable. It the demand for equity which brings on transaction cost.A transaction cost is any activity which is engaged in to satisfy each party to an exchange that the value given and received is in accord with his or her expectations. They arise principally when it is difficult to determine the value of the good or service. Three mechanism for mediating transactions:

market mechanism: transaction is mediated by the price mechanism, and existence of a competitive market reassures both parties that the terms of exchange are equitable.

Bureaucracy: each party contributes labour to a corporate body which mediates the relationship by placing a value on each contribution and then compensating it. The perception of equity depends on a social agreement that the bureaucratic hierarchy has the legitimate authority to provide this mediation

the clan form: if the objectives of individuals are congruent (not mutually exclusive) then the conditions of reciprocity and equity can be met quite differently. E.g. Japanese firms rely on hiring inexperienced workers, socializing them to accept the company’s goals as their own, and compensating them according to length of service, number of dependants, and other non-performance criteria. It is not necessary to compensate based on performance, because the employees have been socialized to do what is best for the firm. The firm also saves money because it is expensive to calculate value-added, and easy to figure out length of service, and number of dependents.

3. The Market Failures FrameworkUnder what conditions are the requirements of each form most efficiently satisfied?Market transactions are governed by contract:

(i) “spot” contract: everything happens instantaneously(ii) “contingent claims” contract: common device for dealing with the future (long term

obligations), but since it’s impossible to predict every possible future event (contingency), only works if you can genuinely trust the other party

(iii) “sequential spot” contract: but after the first few “spot” contracts, the supplier will know the buyer’s needs better than potential competitor suppliers – first mover advantage, so the market mechanism fails and the situation of “small numbers bargaining” (bilateral monopolies), and then transaction cost increases again.

Market Failures Framework:Human Factors Environmental FactorsBounded rationality Uncertainty/ ComplexityOpportunism Small numbersConceptual framework to use: Starting point: all transactions can be mediated entirely by market relations. What conditions will cause some of these market mechanisms to fail and be replaced by bureaucratic mechanism? any two of the factors will produce market failureTwo advantages to the bureaucracy:


1. uses the employment relation, an incomplete contract, which overcomes problem of having to figure out everything all at once (employee is directed by a superior); and

2. can create an atmosphere of trust which leads to some goal congruence and reduces opportunism.4 Extending the Market Failures Framework: ClansBureaucratic structures based on hierarchical surveillance, evaluation and direction. Bureaucracies can fail when the ambiguity of performance evaluation becomes significantly greater than that which brings about market failures. If employees do not trust the employer to distribute awards equitably, they will demand contractual protections such as union representation and transaction costs will rise.Other way of framing the factors which affect efficiency of markets vs employment relations: want to minimize both

1. ambiguity of the measurement of individual performance;2. incongruence of the employees’ and employer’s goals

When (1) is “naturally” low, market relations are efficient (can tolerate opportunism and goal incongruence); when they’re both naturally moderately high, employment relations are better.The clan form is best when ambiguity in performance evaluation is very high (it minimizes goal incongruence)Summary of the three formsMode of Control Normative Requirements Informational RequirementsMarket Reciprocity PricesBureaucracy Reciprocity, legitimate

authorityRules

Clan Legitimate authority, common values and beliefs

Traditions

What is an organization? Any stable pattern of transactions between individuals or aggregations of individualsMarket, bureaucracy and clan organizations exist because each of them, under certain conditions, offers the lowest transaction cost.

Lefebvre-Teillard, Anne Introduction historique au droit des personnes et de la famille, 2 (1996) Presses universitaire de France, 87

Roman pragmatism - after a war 90-88 BC, cities that were not absorbed into the Roman Empire, but which had Roman citizens, were accorded a certain autonomy. To allow the cities to trade and borrow money, they were accorded rights normally reserved to persons (i.e. having a patrimony, undertaking contracts, etc).

the regime originally conceived for cities was extended to colleges, churches, universities, hospitals, etc.

“l’apport du droit savant” – the Roman system survived the fall of the Empire primarily because to the Christian church. During this phase jurists insisted on two points: first, juridical persons had to be recognized by authority (king, church official, etc); second, jurists thought companies should be recognized as legal persons as well.

the old regime – this period is marked by royal intervention. Many royal decrees aimed to appropriate the legal control of colleges, monasteries, etc under the control of the king.

revolution – following the revolution, there was a huge debate about the confiscation of the property of the church. The only surviving legal persons were the state, publics establishments like hospitals, and similar.

the idea that a company could be a separate legal person was considered by the authors of the civil code, see for example art 529.


some cities linked to Rome preserve a degree of autonomy through legal personalitychurches become universitas personarum (Edict of Milan, 313)

Hurst, James Willard The Legitimacy of the Business Corporation in the Law of the United States 1780-1970, 3 (1970) The University Press of Virginia, 112Institutional contributions to policy Processes of policy making are a dimension of legal history, thus it is relevant to seek perspectives on

law’s dealings with the business corp by estimating the contributions of constitution makers, legislators, judges, administrators, and lawyers.

Until middle and late 19th century, state constitution makers said little about corps. Some spelled out legislative authority to grant charters of incorporation, but most state constitutions embraced this authority with simple grant of legislative power.

Framers included no reference to corps in federal Constitution. Corporate instrument developed as a major factor in our social organization. Our constitutional tradition saw law as a marginal force but critically important. We looked to other

institutions like family, church, education, to determine content of social life. Of three branches of government under our constitutions, executive claims oldest authority to issue

corporate charters. Judicial power was not treated as including authority to confer corporate status on individuals by

court decree. Incorporation created forms of social organization capable of binding upon or fixing rights of third parties.

The generalization of legally recognized social forms, the legitimating of organizational patterns, the allocation of special business capacities were all the business of legislatures.

Statutory incorporation provided a means of legitimating standardized patterns of dealing inside and outside an organized group with a firmness of outline and content. Legislation legitimated certain forms and contents of relationships beyond what purely private agreements could accomplish.

Beginning with pathbreaking legislation in New Jersey at end of 19th century, state legislatures added statutes that now expansively gave businessmen power to vary by charter or bylaws the terms which the law otherwise appointed for corporate organization and powers.

Another impact was a growing body of federal law, partly through rules and decisions of the SEC and partly through federal court rulings. The limitations on corporate management were significant.

From the beginning of the use of the corporate device, statute law defined the framework and basic terms on which the legal order would legitimate use of the corp.

Our tradition denied the same scope of policy making to judicial power: inherent limitations in lawmaking by litigation made courts inappropriate agencies to create the general forms of corporation because judges must find their policy-making opportunities within fact specific situations of cases. However, given general sweep of common law growth in the U.S. in the 19th century, judges did make a good deal of corporation law.

Judge-made law did contribute a good deal of specific content to the organizational character of the corp; thus, although the definition of legitimate corporate organization was the prime function of the legislature, in practice the judges did translate the particular operational terms into meaning of the corporate life bestowed by statute.

Out of particular contexts of dependence, judges and later administrators, imposed some measure of fiduciary obligations on corporate insiders. General law of trusts was judge-made in the U.S. and courts thus found themselves in familiar territory when they set standards of good-faith dealing for men who controlled assets of others.

Between roles of legislation and law made by adjudication, we must insert 20th century role of preventative administrative action, notably through SEC, which represented a new potential in public policy-making.


Another important institutional factor is federalism, which has been a large part of the growth of public policy. That state law had a much more affirmative influence in this field than federal law did not derive from any inherent defect of federal authority. Experience proved that the federal Constitution allowed Congress very broad authority to set the legal framework for business conducted through interstate channels and in national markets.

Although Congress clearly conceded to the states the primary role in making law legitimating the organization, the U.S. Supreme Court wielded it own power in Dartmouth College, where it put states on warning that regulation of their corporate creatures must be compatible with the contract clause of the federal Constitution.

At the same time, in Bank of Augusta v. Earle, the Court erected a presumption of comity among states under which a corp might transact business under the protection of local law in states other than its domicile, unless limits were placed upon the corporation’s entry.

New Jersey’s complaisant legislature launched the interstate competition for chartering business. It took the critical step in 1888 when it authorized companies incorporated under its statute to hold stock in other companies.

Meanwhile Delaware had entered the competition. The immediate interest of New Jersey and Delaware was to obtain revenues by attracting a disproportionate amount of the business of issuing corporate charters.

More and more states imitated them from the 1920s to the 1930s: the core of the movement was delegation of broad control to private initiators or controllers of corporate business to write charters and bylaws which gave them the structure and procedures they wanted, thus creating domination of the corporation’s affairs by an oligarchy of key directors and corporate bureaucrats.

The vulnerability of states as separate policy makers required central government action to protect investors and was an impetus to Congress to move to a more positive role.

In the 20th century both state and federal law in effect accepted corps in such sized and shapes as businessmen developed them. The main reliance of the SEC-centred legislation upon disclosure as the control upon corporate power reflect continuing acceptance of substantial corporate autonomy. Yet the growth of the practical power of large corps posed serious questions of the market’s capacity to enforce all relevant responsibility on private powerholders.

The organization and procedures of legal agencies, federalism, precedent, etc. as well as our attitudes towards the market and the autonomy of private will have all had an effect on the development of corporation law. The record tells us that the main influences on public policy came from currents of life outside of the formal legal system. What shaped policy were men’s ideas about productive and acceptable ways of organizing behaviour and their trial and error conceptions of the instruments and conditions necessary to the kind of social patterns they trusted and wanted to adopt. Deepest roots of the law of the business corp drew from general life, not just law.

Hovenkamp, Herbert Enterprise and American Law, 1 (1991) Harvard University Press, 11Mercantilism:

the state must regulate the private business corporation is a creature of the state; this presumed by the very act of

incorporation the state can subsidize corporations, and corporations have public obligations

One advantage of the 19th century limited partnership: it did not need to obtain an act of special incorporation from the state legislature

Limited partnership, then was a first step in the formation of the state corporation: a mechanixm for achieving lower-risk investment by silent investors for an ordinary business enterprise that would have no obligations to the state (and wouldn’t get help from the state either)

Classical political economy: laissez-faire is the best way to encourage economic development


capital naturally gravitates to the best investment Classical model of the corporation

o The corporate form is not a special privilege from the state but merely one of many ways of organizing a business firm

o In a market economy, the peculiar advantage of the corporation is its ability to raise and direct capital more efficiently than other forms of business organization

o Natural consequences: demise of charter theory; the rise of general incorporation act and decline of the special subsidy; the expansion of limited shareholder liability; the narrowing scope of quo warranto and ultra vires; the facilitation of multistate corporate activity; separation of ownership and control

Handlin, Oscar "The Development of the Corporation", The Corporation – A Theological Inquiry, ed. Michael Novak & John W. Cooper, American Enterprise Institute for Public Policy Research, Washington and London, 1

Handlin is an American historian and does not share “the rather gross assumption [of economists] that [the corporation] came to do what it does because people intended it to be the kind of institution that it became.” (172)

In EUR, some kind of “chartering authority” (i.e. monarch) would delegate to some subsidiary body “the power to govern and [would] create a body politic, that is, a body that was competent to use political power for ends that were specified in the instrument that created it, the charter.”

US was originally settled by chartered companies, which operated in terms very similar to those of traditional medieval chartered companies. Although this was effective in other parts of the British Empire (e.g. East India Company, Turkey Company, etc), it didn’t work at all in NA. The settlers had no tolerance for decisions imposed by decree from London: “Because of the remoteness and underdeveloped nature of the area, the population acquired many powers that corporations traditionally had exercised from a central directory.” (173)

Settlers became generally hostile to the corporation form, although did use it once in 1636 to set up Harvard. But this use of the corporation by the colony angered the UK – parliament and the King wanted to retain all the power involved in granting charters. The Massachusetts Charter was revoked, and after this no colony was allowed to establish a corporation through its own governing body.

for 150 years London refused to grant charters, and the colonies couldn’t. This resulted in the development of other forms of organization including things similar to trusts: “These were not partnerships; they were not individual enterprises; they were kinds of cooperative arrangements that were related to trusteeships or the kinds of management that other institutions developed. Self-devised, rudimentary, illegal in strict terms, they kept sprouting up and filling the needs of the actual population at the time.” (175)

“People often went off by themselves and formed bodies politic without waiting to receive a charter … the earliest example is the people who came on the Mayflower and who settled in a part of the New World where they knew they had no right to be. They aimed for Virginia, but their navigation was off and they ended up in New England. Before they settled, they executed a covenant. They mutually agreed among themselves that they would be a body politic and corporate and would act in ways that were spelled out in what amounted to a constitution or bylaws.” (174)

after the American Revolution the government had the power to create charters, however, “somehow they did not work the way they had in Britain”. Reasons for this included:1) general ignorance – just because you have a charter for a bank doesn’t mean you know how to

run a bank. e.g. Bank of North America in Philadelphia; this also included ignorance of the law – most American lawyers were self-trained, had no experience with how to draw up charters, with what went on within the corporation, or with how to resolve the various problems relating to the contract of the corporation with the state.

2) American federalism – it wasn’t exactly clear who had the right to issue charters (state/federal).


This confusion was related to the original ambiguity about sovereignty in the States.3) popular attitude – people were against confining corporate authority to a few individuals: “They

were not against privilege, but everybody had to had a right to have privilege.” (175) by the year 1800 there were more corporations in the US than in all of EUR as time went on, incorporation in US ceased to be a privilege and became a right. Passing

legislation was too onerous, so incorporation started happening through registration. After this point, “incorporation did not signify a privilege, but the opposite of a privilege; it simply meant an opportunity. It meant an opportunity to assemble cooperatively, whatever the nature of that enterprise demanded.”

negative aspects – wastefulness in the form of useful competition, no centralization positive aspects – non-political institutions were created “By the 20th C, this course of development had brought into being a remarkably flexible instrument,

which could serve, as it did in the 19th C, a multiplicity of functions and do so in a way that was attuned to the needs of the times and of the population with which it dealt.” (177)

Horwitz, Morton J. "Santa Clara Revisited: The Development of Corporate Theory", Corporations and Society – Power and Responsibility, ed. by Warren J. Samuels and Arthur S. Miller, 2 Greenwood Press, New York, Westport Connecticut, London, 13 Santa Clara case held that a corp was a person under the Fourteenth Amendment and thus entitled to

protection and it has been affirmed many times, despite a comment by Black and Douglas JJ. that historical writing had led them to conclude that the case was wrongly decided.

The case is usually thought to express a new theory of corporate personality and is asserted to have radically enhanced the position of the business corp in America.

Horwitz hopes to show that the “natural entity” or “real entity” theory of the corp that was supposed to come from this case was nowhere in legal thought when the case was decided and that when the natural entity theory emerged last it was only then gradually absorbed in the Santa Clara precedent to establish new protections for corps.

Santa Clara case in context Real meaning of Santa Clara decision: Santa Clara was one of several others that represented

another effort mounted by business interests after their narrow failure to get the Supreme Court to broadly construe the Fourteenth Amendment in the Slaughterhouse Cases (where 5 to 1 the court held that the equal protection clause was limited to protecting recently freed slaves). Central issue in Slaughterhouse was whether the Fourteenth Amendment had radically altered the constitutional relationship between the states and federal government.

Corporate theory in late 19th and early 20th centuries: notion of corporate personality was written about in Germany, France, England, and America near turn o the century. Uniting these inquiries was rise to prominence during the late 19th century of the business corp as dominant form of economic enterprise.

The corp was the most powerful example of emergence of non-individualists or collectivist legal institutions. By contrast, artificial entity theory sought to restrain the premises of “methodological individualism” (view that only real staring point for legal or political theory was the individual. In Western countries, theories of corporate personality were associated with a crisis of legitimacy in liberal individualism arising from recent emergence of powerful collective institutions.

By late 19th century in the U.S. there was an erosion of “grant” or “concession” theory of the corp, in which the business corp was viewed as an artificial being created by the state with powers limited by charter of incorporation.

Problem faced by thinkers of that time was to reconceptualize the corp after demise of grant theory, which ultimately created a conception of the corp with powers flowing from bottom up, from shareholders to directors to officers.


The first “natural entity” decision of the Supreme Court was in Hale v. Henkel (1905), which extended Fourth Amendment protections to corps. Even though court was hesitant, the entity theory triumphed and corporation and partnership law moved in new directions.

Corporate entity and the power of directors: in 20th century, American legal opinion began to shift to view that powers of board of directors are identical to powers of the corp.

Natural entity theory: starting in 1890s, legal writers attempted to find a vocabulary that would enable them to describe a corp as real or natural entity, whose existence is prior and separate from state.

Main effect of natural entity theory of the business corp was to legitimate large-scale enterprise and to destroy and special basis for state regulation of the corp that derived from its creation by the state. The demise of ultra vires doctrine as well as of constitutional restrictions on foreign corps was a triumph of natural entity theory.

It was also helpful for advocating even more limited shareholder liability and it obliterated the claim that corp mergers were different from individual acquisitions of property.

Conclusion Santa Clara case did not represent the triumph of natural entity theory of the corp. Any such

conception of corporate personality would have been received with hostility by the court at that time since it was still suspicious of corp power and emergence of concentrated enterprise. Hale v. Henkel underlines how late it was before Supreme Court began to move towards natural entity theory.

An important task of legal theory is to uncover specific historical possibilities of legal conceptions, to decode their true meanings in real historical situations.

February 8, Class 10: What is the legal, economic and social significance of corporate legal personality?These readings consider the implications of treating the corporation as a legal person. Samuels articulates some of the puzzles involved with corporate legal personality. Lizée links this rather abstract problem to specific features of Canadian corporate law. Easterbrook and Fischel present the law and economics of corporate legal personality.

Samuels, Warren J. "The Idea of the Corporation as a Person: On the Normative Significance of Judicial Language" Corporations and Society – Power and Responsibility, ed. by Warren J. Samuels and Arthur S. Miller, 5 Greenwood Press, New York, Westport Connecticut, London, 113Objective: examine idea of the corporation as a person and its social role.Hypothesis: ideas (such as the idea of the corporation as a person) are inexorably embodied in legal definitions in such ways as to influence our view of the world and therefore economic and political behaviour, policy and performance, and that in consequence of this recognition, the embodiment of certain ideas in law becomes an object of control.The corporation as sociological realityThe corporation is a social institution:

mode of decision making and of defining reality and values both a product of and a contributor to power structure and belief system of society evolving phenomenon symbiotic and conflictual relationship between the corporation and government (as mode of

organization, focusing human belief system, international relations)Meaning as a dependent and independent variable

how we understand the corporation has enormous consequences for the corporation and for the larger corporation and socioeconomic power and belief systems of which the corporation is a part

also, that power and belief system affects how we understand the corporation. The corporation is an important part of the economic power structure, and power players attempt

to manipulate belief system in order to influence power structure and performance.


The economy as a normative artefact Economy is a product of human action, an artefact, and therefore a normative phenomenon, the

result of a subtle deliberative and non-deliberative decision-making process Therefore the economy is the product of whatever power structure and whatever belief system is

brought to ear on or is operative through the decision-making processRights and the social construction of legal reality

Right: legal recognition of a support for an entitlement; both prescriptive and normative; the vehicle through which both ordinary and legal language establish and express protected interests and thereby correlative and conflicting unprotected and exposed interests.

Rights of economic significance establish the normative structure that is the economyThe transformation of law

Late 19th century U.S.: the foundations were laid for the rise to dominance of the corporate form: rights to life in perpetuity, limited stockholder liability and treatment of the corporation as a person for the purposes of the 14th amendment: emergence of belief system/ ideology to legitimize these legal transformations

Interplay of ideology and power structure and of both with lawLegal definition of socioeconomic reality

Law performs the function of defining social reality, i.e. rights and rules and definitions Legal definitions of (e.g. of the corporation) reality encapsulate the fundamental tautologies at he

basis of the economic systemThe corporation as private and as public phenomenon

If seen as an instrument of government, the corporation is a public phenomenon If seen as an instrument of private incorporators, a corporation is a private phenomenon Two different definitions of reality; the attribution of content to categories (here: private or

public) not only defines reality but channels the policy of the law It is also true that the law is what it is (at least in part) because of corporations

Individualist and Managerialist conceptions of the corporation Two conflicting ideological rationales of the corporate system: (1) the corporation is interpreted

along individualist lines as just another individual economic actor; (2) the corporation and its managers have power not totally circumscribed by the market (i.e. trans-individual social function)

Personhood and the legal definition and recreation of reality By defining reality, law regulates and integrates individual and collective human behaviour

Public and Private governance The affirmation of personhood of the corporation was a legal foundation of the corporation as an

institution perceived in some sense to be independent of the state, i.e. juxtaposed to public governance

At an abstract level, the institutions of government, church and business form the dominant social control of governance system of society

Corporate persons as complex organizations and modes of collective action and identityIrony: affirmation of the corporation as a person allowed the corporation to become so large and complex

The corporation, a “person” also became one of the principal institutions of collective action and identity

The corporation as a given or a variable in economics Economic theory tends to take the economic unit as given Have to look also at what goes on inside the corporation Profit maximization does not explain this, as different individuals are seeking their own goals,

interests What is lacking in economic theory is a theory of power, in this process of replacing the market

with internal decision-making that partake more of power than the impersonal marketConclusion: The functional role of definition in the legal construction of social reality


The corporation is an institution It is collective action in control and in liberation of individual action It is an artefact Both a product of and a participant in the power structure and belief system of society A principal means of organizing and reorganizing the artefact called the economy By making legal concepts, law helps make economic reality (think corporation as person), i.e.

ideas are variables in socioeconomic organization

Lizée, Marcel « Essai sur la nature de la société par actions », 39 (1994) McGill Law Journal, No. 3, 502

the corporation has evolved beyond its original conceptual origins; it is more than a simple legal fiction, as it possesses a real and separate existence distinct from its constituent parts; the corporation is a juridical construct overlying an enterprise, whose social role is not limited to serving the interests of the shareholders, but which equally serves the interests of others (e.g. employees) who are integral to its functioning [summary of English abstract – if any of the rest sounds odd, it may be a translation problem on my part – please ask for clarification!]

law cannot logically recognize the juridical personality of companies unless it admits that they are entities distinct from their members. Yet there is debate over whether or not this is sensible, as corporations are in some senses intangible (analogy to atoms, which we also cannot see but believe exist)

distinguishes between authentic fiction (completely false and non-existent) and explanatory fiction (“fiction explicative”, something we recognize but do not know how to explain scientifically).

another problem with considering corporations as some form of legal fiction is that it can lead to incoherence: e.g. longstanding refusal to attach criminal responsibility to corporations, despite willingness to allow contractual liability

law has considered corporations as “personne morales”, which is actually a fiction, since the corporation is an entity but is impersonal. In accepting this, we must be careful to distinguish between actual humans, who have natural rights; and corporations, which have only the powers conceded to achieve their goals.

law is not the only discipline that doesn’t quite know how to think about corporations. Both sociology and management theory are useful: in sociology there is a school of thought that insists that we must not reify the group by considering it a real entity separate and distinct from the people that compose it; however, there is another groups that persists in considering organizations are real separate entities. In systems theory (management) the separate entity is considered to be the result of the sum of the parts. Systems can be considered simultaneously “un et plusieurs”. For those observing the system, it depends on the perspective whether you will see it as a whole or as an assembly of parts.

Easterbrook, Frank H. and Fischel, Daniel R. The Economic Structure of Corporate Law, 2 (1991) Harvard University Press.Limited Liability It is a distinguishing feature of corporate law. Although partners are personally liable, shareholders

are not for the debts of the corp. To say that liability is limited means that shareholders are not liable for more than the amount they chip in.

Rationale of Limited Liability Limited liability and the theory of the firm: publicly held corps dominate other forms when the

technology of production requires firms to combine both specialized skills and large amounts of capital. Limited liability reduces the costs because it decreases the need to monitor agents; reduces the costs of monitoring other shareholders; gives managers incentives to act efficiently; makes it possible for market prices to reflect additional information about the value of firms; allows more


efficient diversification; and facilitates optimal investment decisions. Limited liability and firms’ cost of capital: it does not eliminate ruin and someone must bear the

cost when firms fail. But it is an arrangement under which the loss is swallowed rather than shifted, that is, each investor has a cap on the loss she will bear.

Limited liability is a risk-sharing arrangement. Under limited liability, both shareholders and creditors risk the loss of their investments; under unlimited liability, shareholders would bear almost all risk

Insurance as an alternative to limited liability: a close substitute is insurance, but why do we see limited liability rather than insurance against bankruptcy? Transactions costs of shareholders’ individually purchasing insurance are prohibitive (plus each one would have to negotiate with the insurer). An advantage of purchasing insurance from separate insurers is that some of the free-rider problems faced by creditors are avoided. Plus third party insurers might have superior ability to monitor.

However, a rule of limited liability economizes on transaction costs by eliminating the need for individual negotiations with every creditor. It also makes a difference if the firm were to purchase inadequate insurance or if insurance would not be available in a competitive market. Complete bankruptcy insurance would be impossible since bankruptcies can be cause by economy-wide events against which the insurer cannot diversify. Complete bankruptcy insurance also creates a moral hazard as it invites managers to take excessive risks.

Limited liability and the externalization of risk Because limited liability increases the probability that there will be insufficient assets to pay

creditors’ claims, shareholders reap all the benefits but do not bear all of the costs, which are borne in part by the creditors. Critics of limited liability raise the issue of a moral hazard, which is the incentive created by limited liability to transfer the cost of risky activity to creditors.

Externalization of risk imposes social costs and thus is undesirable. The social loss from reducing investment in certain projects might far exceed the gains from reducing moral hazard.

In any case, the magnitude of the externality under limited liability has been exaggerated. Limited liability and voluntary creditors: employees, consumers, trade creditors, and lenders are

voluntary creditors and the compensation they demand is a function of the risk they face. One risk is non-payment because of limited liability.

If the compensation that must be paid to third parties exceeds the benefits to the fimr, the activity will not be undertaken under a rule of limited or unlimited liability. This is an application of the Coase Theorem. Managers will take steps to reduce risk only as long as the gains from risk reduction exceed the costs.

Limited liability’s greatest effect is on the probability that any given creditor will be paid ex post. Even if firms pay for engaging in risky activities, creditors of failed businesses are less likely to receive full compensation under limited liability rule.

The ability of potential victims to protect themselves against loss through insurance is a strong reason for disregarding distributional concerns in choosing among liability rules.

Involuntary creditors and corporations’ incentives to insure: when corps must pay for risky activities, they only undertake projects whose social benefits equal social costs at the margin. Firms capture benefits from such activities but only bear some of the costs – others are shifted to involuntary creditors. This is a real cost of limited liability, but its magnitude is reduced by corporations’ incentives to insure.

Common explanation for insurance is risk aversion. Insurance enables those are risk-averse to pay risk-neutral parties to bear risk.

Their argument is not that the firms’ incentive to purchase insurance eliminates the possibility that firms will engage in excessively risky activities. Their discussion of firms’ incentives to insure suggests that firms will insure in some situations where people and partnerships would not.

Piercing the corporate veil


Courts sometimes allow creditors to reach the assets of shareholders. The doctrine of piercing the corporate veil makes economic sense: the cases in this area may be understood as attempts to balance the benefits of limited liability as against its costs. Courts are more likely to allow creditors to reach shareholders’ assets where limited liability provides minimal gains, while creating a high probability that the will engage in excessive risk-taking.

Close versus public corporations: almost every case in which a court allowed creditors to reach shareholders’ assets, it involved a close corporation, in which there is must less separation between management and risk bearing. This has implications for the role of limited liability because those who supply capital in close corps are also involved in decision making, and thus, limited liability does not reduce monitoring costs. In close corps, takeover bids are impossible and there is also more incentive for managers to undertake risky activities in close corps.

With unlimited liability, investor-managers bear all of the costs of their actions, while with limited liability, they can limit their own risk and transfer some of it to third parties. Piercing the veil reduces the extent to which third parties bear these costs.

Corporate versus personal shareholders: other major category of piercing cases involves parent-subsidiary combinations, where creditors of subsidiaries try to go after the parent.

Moral hazard problem is greater in this situation because subsidiaries have less incentive to insure. Bankruptcy of a subsidiary will not cause managers to lose their positions. If limited liability is absolute, a parent can form a subsidiary for the purposes of engaging in risky activities. If it goes well, parent benefits; it if does not, subsidiary declares bankruptcy and parent creates another with the same managers. The asymmetry between the benefits and costs, if limited liability were absolute, would create incentives to engage in risky activities.

Contracts versus torts, and the fraud or misrepresentation exception: courts are more willing to disregard the corporate veil in tort than in contract cases. The distinction between contract and tort breaks down in cases where the debtor engages in fraud or misrepresentation. Creditors must be able to asses the risk of default accurately and if she is misled, the creditor will not demand adequate compensation, leading to excessive amount of risk taking by firms because some costs will be shifted to creditors.

Courts respond to this by allowing creditors to go beyond assets of corp in cases of fraud or misrepresentation.

Undercapitalization: a final factor emphasized by courts in piercing the veil is the extent of the firm’s capitalization. The lower the firm’s capital, the more incentive there is to engage in risky activities.

Allowing creditors to look beyond the assets of the undercapitalized corporate debtor provides the debtor with the incentive to disclose its situation at the time of the transaction. The creditor can then decide not to transact or charge more for the risk.

Alternative methods for reducing moral hazard Piercing corporate veil is one of several ways of decreasing the incentive created by limited liability

to engage in overly risky activities. Legislatively imposed minimum-capitalization requirements are one method of internalizing costs of

risk taking. But can be problematic because of administrative cost associated with determining what amount of capital firms should raise, as well as the cost of error.

Mandatory insurance requirements are somewhat similar because they too involved administrative costs, but the effect of mandatory insurance on new firms might be greater than minimum capitalization requirements.

Another method is to impose liability on managers as well as enterprises. Managerial liability is an additional risk for which firms must compensate managers. If managers may be held liable, they have incentive to monitor the firm’s capitalization and insurance because they bear the cost of incomplete risk shifting. But the risk shifting may not work perfectly (e.g. manager liable for mass torts could not shift all of this risk).


Final method is reducing the incentive to engage in overly risky activities created by limited liability is regulation of inputs (e.g. regulation of nuclear power plants could be justified as a response to perverse incentives created by limited liability). However, regulators have no better incentives than market participants to balance the social costs and benefits of engaging in certain activities.

PART 4: AGENCY, FIDUCIARY RELATIONS AND THE CORPORATION: THE DEPLOYMENT, ORGANIZATION, AND REINFORCEMENT OF TRUST

Parallel VanDuzer Readings: Chapters 5, 8 & 9

February 10, Class 11: What is the role of fiduciary relationships within the corporation?Fiduciary duties dominate the legal landscape of the corporation. Much corporate law doctrine has to do with the duties of directors, managers and controlling shareholders and with the rights of shareholders, especially minority shareholders. These readings address why this is so, especially from an economic perspective.

Dent, George W. Jr. "Toward Unifying Ownership and Control in the Public Corporation", (1989) Wisconsin Law Review, 881 (CB 229-251)

I. Introduction: Since Berle-Means published their theories the separation of ownership & control has been a central dilemma in corporate law. Most observers concede that separation of ownership and control lead to economic inefficiencies and mistreatment of shareholders… “separation of ownership and control stems from management’s domination of proxy voting. Although commentators recognize this, most accept it as inevitable; shareholders are too numerous, scattered and indifferent to coordinate their voting. So long as management controls proxies, corporate government reform efforts are doomed. An effective shareholder franchise, however, would remedy the separation of ownership and control, and with it, most other corporate governance problems.” II. Separation of Ownership and Control: A Taxonomy of Corporate Theory

A. The Berle-Means Thesis - Berle-Means in a nutshell: ownership + control separated because of pattern of stock ownership in public companies. Managers engineer election of BoD (by shareholders). BoD then subservient to managers. Notes that the public would have been receptive to this because of recent stock market crash/Depression.

B. Rejecting the Separation Hypothesis: Executive Groups and Neoclassicists (Economists)Executives portray themselves as beleaguered by powerful interests (labour, suppliers, consumers, political activists, governments). Argue that few managers mess up, and if so are punished by other managers/ outside directors. The neoclassical economists claim that managers are compelled by economic forces to maximize profits, as shareholders would be if they controlled the firm. By contrast, author argues that managers’ interests diverge from those of shareholders as “[m]anagers fear risk more than shareholders do because managers cannot diversify their investment of human capital as shareholders can diversify their investments of money… Managers… pursue growth rather than maximum share value.” Allowing managers too much discretion cheats investors, is inefficient, & undermines the economy.

C. Support for Separation of Ownership and Control: ManagerialismThis school of thought conceptualizes corporations as “social institutions accountable not only to shareholders but to many constituencies including creditors, consumers, etc.” Broad perspective of management balances needs of firms’ many publics. But author thinks this is undemocratic – why should the “corporate oligarchy” have control of the company’s social policy development?

D. Deploring Corporate Separation: Corporate ReformersOutside directors lack the incentives to assert independence and maximize profits. Most outsiders are well-paid executives of other companies. Their compensation as outside directors is a small fraction of


their income and usually less pay per hour than their full time jobs. Despite this, they have certain liabilities, and the result is that they are even more risk-averse than managers.III. The Source of Separation: Proxy VotingIndividual shareholders in widely-held corporations can’t do much to effect the corporation. This creates “rational apathy”. Managers do not like active shareholders and can deny them important information. There are also numerous legal pitfalls for individual shareholders that meet, which depend on the amount of stock thy own jointly, e.g. soliciting proxies from more than ten shareholders requires the filing of a detailed proxy statement. There is also the issue of the “Wall Street Rule” = vote with management or sell. Managerial control rests on a proxy system dictated by government not by the market.IV. Returning Proxy Control to the Shareholders

A. The ProposalThinks that giving shareholders control of the proxy system is a necessary and sufficient condition for uniting ownership and control. The largest shareholders should be able to access the corporate treasury to canvas for proxy votes – as they have largest stake in corporation, will be most diligent in improving corporate performance. Appointing minority of directors doesn’t work, as if they are stubbornly independent they will be excluded and outvoted (therefore ineffective).

B. Benefits of Shareholder ControlShareholder control would result in executive compensation tied more tightly to corporate performance than to growth; it would reduce cronyism, nepotism, and incompetence in public firms; and it would transform corporate finance by reducing retention of earnings and increasing payouts (e.g. through ending such wasteful practices as using accounting methods that increase taxes and reported earnings without affecting real earnings, curtailing unprofitable acquisitions, and spurring deconglomeration). Shareholder control would also have a large effect in the area of takeovers: shareholder control would actually reduce the incidence of takeovers. Takeovers serve to close the gap between a corporation’s stock market price and fundamental value that arises from fears of misinvestment/mismanagement. Shareholder control would calm fears of misinvestment and discourage uninformed trading. Most importantly, shareholder control would rationalize the corporate governance structure, starting with the role and structure of the BOD. The role of outside directors is vague – those who can best define what they should be up to are those who are most affected by their actions, i.e. shareholders.

C. Possible Objections1. Organization is oligarchy: a shareholder proxy committee would serve its own interests, rather than shareholders at large. Reject because – they would be subject to fiduciary obligations; opportunities for these shareholders to benefit individually would be extremely limited (law prohibits discrimination among shareholders); insider trading info is available only a few days a year and they can be prohibited from trading at that time; and antitrust concerns could be handled by existing laws against interlocking directorates. 2. Shareholder control would expose management to mistreatment: the experience of invest-controlled firms shows otherwise. 3. If the proposal were beneficial it would already have been adopted: someone has to be firs, and there have not been mechanisms for change. 4. Shareholders are obsessed with short term profits: managers’ longer term view is not necessarily better – managers prefer to retain and reinvest earnings even if the return on investment is lower than the prevailing market rate; shareholders prefer that earnings be paid out unless they can be reinvested at a rate that exceeds those of other investment opportunities. Based on the premise of the market economy, shareholders are right. V. ConclusionsThose who have an effective voice are less likely to exit from it, so shareholders will be less likely to follow the Wall Street rule and will work to improve the corporation instead. The current corporate governance system has major problems; even if this proposal is not perfect it is a serious improvement.

Frankel, Tamar "Fiduciary Law" 71 (1983) California La Review, no. 3, 795

An unprecedented expansion and development of fiduciary law has been occurring throughout the 20 th C,


however, fiduciary law is not generally studied as a coherent body of law. There are 2 good reasons for doing so: 1) increasing importance of fiduciaries in modern society; 2) analogizing current roles to pre-existing fiduciary relations is not satisfactory/often inappropriate.The Importance of Fiduciary Relations and Fiduciary Law – Relationships can be described as status (parties must rely on each other to satisfy needs and desires; one party generally has much more power; exit and entry from relationship controlled by law, not by parties – e.g. parent/child); contract (parties must rely on each other to satisfy needs and desires, but cannot use force or monopoly to achieve purpose – must use suasion, negotiation; less secure than status relationships, as no general obligation to care for other/ no right to be taken care of; main role of law is to enforce rules that parties create for themselves); and fiduciary (“entrustor” is dependent on “fiduciary”, but generally only for a particular service; entrustor can generally choose among different fiduciaries and negotiate the terms of the relationship; relationship designed only to satisfy entrustor’s needs: “Thus, fiduciary relations combine the bargaining freedom inherent in contract relations with a limited form of the power and dependence of status relations.”) societies can also be described in terms of the predominant relationships present. For example, feudal

England during the Middle Ages was a status society; the US during the Industrial Revolution was a contract society; Frankel thinks that “we are currently witnessing the emergence of a society predominantly based on fiduciary relations… [which] emphasize cooperation and identity of interest pursuant to acceptable but imposed standards. [Fiduciary relationships] permit the government to moderate between altruistic goals and individualistic, selfish desires, as well as between the social goal of increasing the common welfare and the individual desire to appropriate more than a ‘fair share’.”

fiduciary relationships are replacing other forms of social control which have weakened. It is also the result of pooling (e.g. $ for investment) and specialization (e.g. how to invest for best return).

current methods of developing fiduciary relations are unacceptable because these relations are evolving too quickly; also the courts are inconsistent in their analogies to existing fiduciary models.

The Inherent Risk of Fiduciary Relations – fiduciary relations are characterized by 2 features: 1) the fiduciary acts as a substitute for the entrustor, to benefit the entrustor; 2) fiduciary obtains power from the entrustor or from a 3P for the sole purpose of enabling the fiduciary to act effectively. there is always a risk that the fiduciary will abuse their power, but if hand over less power fiduciary is

less effective. Still, it is important to remember that the entrustor’s vulnerability to abuse of power does not result from inequality of bargaining power – rather, it stems from the structure and nature of this kind of relationship.

the magnitude of the risk of abuse depends on three factors:1) the purpose for which the relationship was established and the nature of the power delegated2) the extent to the power delegated3) the availability of protective mechanisms to reduce the probability of abuse

there are some non-legal ways of reducing the likelihood of abuse of power. These include 1) using fiduciaries that have no conflict of interest with the entrustor

- if no conflict, when fiduciary acts in own interest will act in entrustor’s interest - but this is difficult to arrange, especially in financial situations

2) inducing fiduciaries to refrain from abuse of power through rewards- e.g. financial compensation tied to performance- but this can shift risk of events beyond fiduciary’s control (i.e. beyond own risk of abuse

of power) and may produce undesirable incentives. 3) imposing controls on fiduciaries

- termination (but can also work against entrustor who can be stuck without anyone to fill this role)

- contract (attempt to limit im/permissible uses of powers)- direct control (but may be inefficient or unrealistic and may undermine the very purpose

of the fiduciary relation)


- indirect control (restrict fiduciary’s discretion)4) monitoring fiduciaries

- can require reports, may be assisted by competitive market for fiduciary’s services5) non-judicial regulation (professional societies, etc)

- government agencies/ require membership in professional organization, insurance, etcJudicial Regulation of Fiduciaries – fiduciary law is not about the contexts in which fiduciaries act (e.g. as agents, in trusts, through a function of office): “The same fiduciary principles apply to fiduciary power, and are superimposed on the different bodies of law governing the contexts in which that power appears.” an important characteristic of fiduciary law is that it regulates only the fiduciary, not the entrustor.

Even when duties are imposed on entrustor (e.g. to repay fiduciary for expenses incurred) it is to encourage the fiduciary to act diligently.

once a fiduciary relationship is deemed to exist, the parties cannot waive the courts’ supervision. The courts will require the fiduciary to act with loyalty and skill, and in the entrustor’s best interests. The extent of fiduciary duty varies with the potential abuse of power stemming from the relationship.

much fiduciary law is designed to prevent the fiduciary from using delegated power to further interests other than those of the entrustor

fiduciary law often creates property rights for the entrustor against the fiduciary as a form of protection. This allows the entrustor to take advantage of all the strong property remedies out there.

note that the law does not impose obligations on the fiduciary beyond what they assumed – a person is free to refuse to act as a fiduciary. However, once someone chooses to so act, they are stuck in the role of the moral, altruistic person and must behave in a selfless fashion.

A Model of Fiduciary Law – Frankel’s model has three key components: providing incentives to both parties; fairness; and lowering the aggregate cost of the relationship. providing incentives to the parties: to avoid deterring fiduciaries, the burden of regulation should

be limited to what a reasonable fiduciary might agree to bear; similarly to avoid deterring entrustors, they should be provided with the minimal protection that a reasonable entrustor would insist upon.

fairness: a fair fiduciary law would shift the costs of protecting against abuse from the entrustor to the fiduciary and the courts. Without regulation the entrustor cannot bargain effectively. If the cost is placed partially on the fiduciary, they can shift all/some of the cost back to the entrustor through bargaining.

lowering the aggregate cost of the relation: Frankel proposes 5 cost-shifting principles:1) courts should bear some of the costs because society considers fiduciary relations desirable2) the extent of any legal intervention should fit the nature and purpose of the parties’ arrangements3) the benefits of the relation should be preserved for the entrustor4) the overall costs of the relation should be reduced as much as possible5) the fiduciary should bear costs that he would have borne voluntarily or that benefit him

Conclusion: “As members in our society become increasingly interdependent fiduciary relations become predominant and fiduciary law increasingly important. To develop the law in a rational fashion the courts should examine fiduciary relations separately from the legal contexts in which they arise and design the rules not by analogies to prototypical relations but by evaluating the fiduciary power and its potential abuse. Fiduciary law should reduce the costs of preventing this abuse, leaving the parties free to allocate the costs between themselves. The law will thus encourage members of society to enter into the relation, seek each other’s services, exercise power responsibly, and act for each other’s benefit.” (273)

Hart, Oliver "An Economist’s View of Fiduciary Duty", (1993) 43 University of Toronto Law Journal, 299 Theme: role of stakeholder in corporate decision-making. Until recently economists have had little to say about fiduciary duty because the economic literature

was dominated by neoclassical theory, which views the firm as a set of feasible production plans


presided over by a selfless and compliant manager. Such a view portrays the modern business enterprise in caricature terms. The theory has nothing to

say about key issues of the stakeholder debate: fiduciary duty, board representation, voting rights. Some attempts have been made to enrich the theory and an important development has been

principle-agent theory, which provides the foundations for a managerial theory of the firm. But principal-agent theory is still not rich enough to encompass the issues of the stakeholder debate.

To understand fiduciary duty, board representation, and voting rights, then we must depart from the comprehensive contracting world of principle-agent theory and incorporate the transaction cost of writing contracts and the consequent contractual incompleteness.

Tentative thoughts on fiduciary duty It is easy to see why it is desirable for managers to owe a fiduciary duty to shareholders – they are the

owners of the company and yet have very little involvement in the day-to-day business decisions, which is delegated to management. So management has lots of power that it can use for both good (increase firm value) and bad (line their pockets). Without a requirement to act on behalf of shareholders, there would be little to stop management from overpaying, hiring family, etc.

Argument for a narrow interpretation of fiduciary duty Two main arguments: loyalty is scarce (and more management owes to creditors and workers, the less

is available for shareholders) and a broader definition of fiduciary duty is essentially vacuous (because it allows management to justify almost any action on the grounds that it benefits some group.

Argument not persuasive because loyalty is complicated commodity and not obvious that it comes in fixed supply.

However it may be in best interest of firm to specify the duties management owes. Another argument against broadening the definition is that the ambiguity of a broad notion gives

management the freedom to pursue its own agenda.Argument for a broad interpretation of fiduciary duty Reducing shareholder-creditor conflicts: if a firm issues risky debt as well as equity, then creditors’

claims are not fully protected and managers may undertake riskier investments since these help shareholders. But they are not in the interest of shareholders and creditors taken together. A more efficient outcome is achieved if fiduciary duty is extended to creditors as well.

Helping to sustain implicit contracts: implicit contract can be upheld only if other party believes that the firm will not renege on its commitment. But management’s promise not to renege is harder to sustain if its fiduciary duty to shareholders is interpreted narrowly.

Reducing conflicts between different cohorts of shareholders: conflicts of interest can occur within a single class of claimants – an action that is in the interest of shareholders as a whole may not be in the interest of each cohort of shareholders. It is best if management owes a fiduciary duty to all shareholders, current and future.

Encouraging the firm to behave altruistically: large corps often claim to have goals that go beyond the pursuit of profit. Charitable contributions can be controversial because not clear if made with consent of owners or whether are a form of self-promoting behaviour by managers. An argument in favour of charitable contributions is that a broad notion of fiduciary duty extends beyond shareholders, creditors, and workers to the community.

Argument for mandatory rules Nothing said justifies the state imposing a mandatory notion of fiduciary duty on firms; the most it

could offer would be a narrow default rule. A mandatory rule may be desirable in that society would be better off if management adopted a broad

notion of fiduciary duty. But given the complexities of a firm’s impact on the economy, mandating a broad fiduciary rule may

reduce rather than increase production.Summary Better approach may be to adopted a narrow interpretation of fiduciary duty as being owed to


shareholders and allow firms that want a different rule to opt out. Adoption of mandatory rule is likely to do more harm than good.

Easterbrook, Frank H. and Fischel, Daniel R. The Economic Structure of Corporate Law, 4 (1991) Harvard University Press, 90The Functions of Fiduciary Duties

Corporate directors and other managers are said to be fiduciaries Fiduciary obligations rare in contracts – why do they come up here? Corporations are enduring (relational) contracts. For suppliers, labourers, debt investors, even

employees, can write contracts in enough detail that there’s no need invoke fiduciary obligations The holder of the residual claim gets few explicit promises: just the right to vote and the

protection of fiduciary principles. (duty of loyalty and duty of care). Since they bear the marginal risks of the firm, they have the incentive to make the best management incentives; since the managers make these decisions, the only way to get investors to invest it to have managers pledge their careful and honest services.

When one person exercises authority that affects another’s wealth, interest may diverge. How to control the divergence of interests? Options include: rewarding good managers with bonus; having a threat of sale of corporate control; having a competitive market so that if the managers do a bad job they’ll lose their position because the firm won’t survive. These methods are costly (monitoring) and imperfect (who monitors the monitors?)

The fiduciary principle is an alternative to elaborate promises and all this monitoring. Socially optimal fiduciary rules approximate the bargain investors and managers would have

reached if they could have bargained at no cost. Fiduciary principle is a rule for completing incomplete bargains in a contractual structure, i.e.

reason for having fiduciary principles is high cost of specifying things by express contractBusiness Judgment and the Limits of Liability Rules

Business judgment rule: doctrine which absolves managers of liability even though their conduct is negligent.

Statements of the rule vary; what’s important is that it’s very deferential Based on recognition that investor’s wealth would be lower if managers’ decisions were routinely

subjected to strict judicial review because: judge’s lack competence in making business decisions; fewer talented people would be willing to serve as directors; and that there are limits on the use of liability rules to assure contractual performance (this is explained more in following points)

Long term contracts (like corporate ones) have built-in enforcement mechanisms:o Repeat transactions (e.g. always trying to raise money) provide an incentive to perform

wello Potent information market – poor performance leads the market to respond in ways that

bring the costs home to managers: investors will pay less for shares; accurate price signals contribute to efficient labour markets (share price is an indication of how good a firm is); capital markets facilitate the market for corporate control efficient operation of the capital, labour and takeover markets all raise the future costs of poor performance

o Firm-specified investment in human capital: changing managers is costly for the firm because the replacements lack the firm-specific expertise and costly for the manager who lacks the firm-specific expertise for other firms. These costs provide incentives for both sides to perform well.

Costly and inaccurate litigationo How can a court know whether a poor outcome of a business decision is attributable to

poor management or to the many other things that affect firms?


o Relative attitudes towards risk: managers want to avoid risk. Shareholders manage risk by diversifying their portfolio so they are OK with managers taking risk if that also means chance of very high returns. Business judgment rule lowers the risk for managers, meaning less to pay in compensation and insurance.

o Natural selection: inferior managers are “selected out,” so there’s an incentive to be good. Bad judges are not selected out. Business judgment rule insulates honest decisions from review so market pressure can act on them.

ApplicationsThe Decline of the ultra vires doctrine

Courts now defer to markets, again demonstrating conformity of law and economicsThe Distinction between the duty of care and the duty of loyalty

Duty of care: act as a prudent person does in the management of his own affairs Duty of loyalty: maximize the investor’s wealth rather than one’s own Both are agency costs, conflicts of interest in an economic sense, that reduce shareholder’s wealth Distinction: differential payoffs from breach and policing Duty of loyalty: often involve spectacular one-shot appropriations, in which subsequent penalties

through markets are inadequate; easier for courts to detect appropriations than to detect negligence (breach of duty of care)

Procedural but not Substantive Review of Conflict-of-Interest Transactions Core of the duty of loyalty: managers must prefer investors’ interests to their own in the even of

conflict Courts require proof that any conflict of interest transaction is “fair” to the firm, i.e. the firm

receives a deal at least as good as it could have obtained in an arm’s length transaction – this is a market test

Even this inquiry into market conditions is forgone when he transactions have been approved by independent monitors, such as disinterested directors

Decisions are subject to a lower standard of judicial review if made by disinterested directors This does not ensure that a given transaction will increase shareholder wealth

Indemnification and Insurance Corporate law provides firms with flexibility in deciding whether to provide indemnification or

insurance to managers for expenses incurred in litigation. Indemnification and insurance allow firms to contract around liability rules when markets are

cheaper than courts.Restrictions on Derivative Litigation

Small shareholders and their attorneys have poor incentives to maximize the value of the firm (because they don’t have much at stake)

Therefore, legal rules should place restrictions on the ability to bring derivative suits. There are a series of legal rules which do just this, e.g. ability of directors to terminate derivative

suits by making ordinary business judgments about the costs and benefits of further litigation Which of the two (both imperfect) sets of decision-makers, managers allegedly involved in

wrongdoing, or shareholders with little at stake, is more likely to make decisions that increase the value of the firm? Answer is unclear

Not surprisingly, different judges have reached different conclusions about when directors charged with wrongdoing can dismiss derivative suits.

The Anomalous Duty to be Informed Supreme Court of Delaware in Smith v. Van Gorkom held that the business judgement rule

applies only to decisions that are “informed” and that managers who did not study the proposal or consult any outside experts breached their fiduciary duty to make an informed decision

This case was an outlier However, it led to a big change in Delaware law; a provision in the corporate code authorizing

firms to eliminate damages liability in duty-of-care cases


How much information must managers acquire before making a decision? This leads to the precise difficulties the business judgement rule is designed to avoid

Information is costly, and investors want managers to spend on knowledge only to the point where an additional dollar generates that much in better decisions

Allowing shareholders to challenge business decisions that they say were not “informed” has the effect of substituting the business judgement of some shareholders, their attorney and a court for that of the managers.

February 15, Class 12: How does the law protect corporate fiduciary obligations?These readings address liability for breach of corporate fiduciary duties in an attempt to assess how and why the law should protect trust within the firm and generated by the firm.

Kraakman, Reinier "The Economic Functions of Corporate Liability", 178

this article attempts to answer the question of when liability rules should directly target economic incentives of directors, executives, and outside board members in order to discourage business delicts that benefit the corporation at the expense of 3P or the public. It is the most painful article I’ve read to date. There is a lot of talk about incentives for rule-breaking, and shifting of risk (think 1st year torts).

the author thinks that enterprise-level liability should be dominant (i.e. corporations should be liable instead of individuals), except in specific circumstances where individual liability is required for effective enforcement of legal norms.

the general rule is that of “‘dual liability’ in which both the firm and its culpable agents share potential liability for the delicts that corporate activities inflict on 3P or the public.” However, in practical terms subsidizes insurance, and routine indemnification effectively mitigate the personal liability of corporate actors unless there is a non-transferable punishment such as imprisonment.

contractual shifting of personal liability is accepted because it is inefficient to make individuals personally liable (expensive to monitor, and to certain extent necessary for corporate power holders to incur personal liability risks as routine occupational hazard)

“the business judgement rule acts as a judicially-imposed, standard-form indemnification contract, which automatically relieves the board … from liability to shareholders for negligently failing to prevent corporate delicts.” (295)

from the narrow economic perspective, the US rule of allowing managers to be indemnified except when they have knowingly broken laws should be considered a proxy for the screening function of dual liability in ordinary tort. It encourages managers to continue taking ordinary risks, but makes them pay up for egregious offences.

gatekeeping liability includes all individual tort and criminal sanctions that create incentives to prevent 3P delicts (e.g. Directors’ duty of care).

outside members of the Board are tempting targets for this kind of liability, because they have assets and careers outside the firm (which means that they have less to gain/more to lose than inside managers when it comes to profiting from corporate offences). This should make them more difficult to corrupt, if they are not pre-selected for their flexible morals/willingness to take risks.

sorry this is such a short summary, I really thought this article was crap – there is only one slide, and nothing in my class notes about this so I don’t think it is too important. Let me know though if you want more…

Undercapitalization is the failure of a corporation to maintain sufficient capital to meet its financial responsibilities.

Teubner, Gunther "Corporate Fiduciary Duties and their Beneficiaries – A Functional Approach to the Legal Institutionalization of Corporate Responsibility", 149


Introduction: a reformulation of Berle-Dodd Berle and Dodd put forth radically different views on the legal construction of fiduciary duties.

Berle’s was minimalist (management’s powers are not absolute) and Dodd’s was maximalist (law should require that corporate managers hold powers in trust for shareholders and social groups, including supplies, consumers, and employees). This would signify the legal acknowledgement of noneconomic corporate social responsibility (CSR) to society.

There are three lessons to learn from various concepts of CSR:1. Berle-Dodd discussion focuses too narrowly on legal trust relation and so it limited in scope to

articulation of concomitant duties and liabilities.2. Berle-Dodd discussion poses wrong question by searching for those social groups that are

beneficiaries of fiduciary duties. Instead, one should reevaluate fiduciary duties by means of a functional approach to CSR.

3. Doctrine of fiduciary responsibility should shift its focus from substantive norms to procedural mechanisms.

Comparative aspects: fiduciary responsibility and “Unternehmensinteresse” U.S. law has impressive body of rules based on these principles. The question is how the law reacts to a managerial strategy which limits the principle of profit-

maximation in the interest of other social groups. Classic case was Dodge v. Ford Motor Co. (1919), where Ford announced that no further dividends would be paid and that the future of the business was to be devoted to reducing prices in the interest of consumers and to create more jobs for workers. The Michigan Supreme Court compelled the declaration of additional dividends on the grounds that a business is carried on for the profit of the shareholders.

The subsequent development led to remarkable changes in U.S. law’s position. The ultra vires doctrine has been almost abandoned and fiduciary duty doctrine has been modified so that shareholders’ interests should be weighed against the interests of other social groups.

This development towards a legal recognition of corporate voluntarism has been eased by the benefit rule (corporate activities were authorized only if there was a reasonable probability that consideration would flow directly to the corp), now expanded to include even an indirect benefit.

Another important development was the business judgment rule, which grants a high degree of autonomy to managers and had the effect of watering down fiduciary responsibility to a vague formula.

The legal acknowledgement of social responsibility is limited to corporate voluntarism and also to a negative formulation.

Some weak trends may create an affirmative fiduciary duty in terms of public responsibility, such as the overlapping of external tort obligations of the corp and internal duties of management or new disclosure obligations.

German law While an affirmative duty was prescribed by law early on, its practical consequences have been

reduced to almost nil. In the reform of German corps, management was granted a lot of autonomy but was also bound by Gemeinwohlklausel, which involved directing the company in accordance with its working force and common welfare of the people and empire. However, in practice, it has been reduced to a norm without a sanction.

Although institutional equivalent of fiduciary responsibility led nowhere, the functional equivalent has brought about quite a change. The law acknowledges managerial autonomy, but obligations were expanded to include larger public interests. While fiduciary duties focus on obligations of management, German development changes the legal construction into a coalition of different social groups and focuses on constitution of the firm, membership, representation, and control.

Functional equivalence? Both the American and German principles have the function of imposing broader social

responsibilities, but these are translated into different legal mechanisms and doctrinal constructions.Theoretical orientation: a functional approach to CSR


Dimensions of the controversy on CSR Beneficiaries: The limits of pluralism: different theoretical approaches to CSR as to which social

groups ought to be favoured. Some theories hold that shareholders are sole beneficiaries, while others go further, to integrate various internal participants of the firm, and see competing interests (shareholders, employees, etc.). Some also include consumer interests.

An internal perspective overlooks the social function of the corporate organization. It does not exist simply as a self-serving institution for the unique benefits of its shareholders and workers, but exists above all, to fulfill a broader role in society.

Pluralist approach derives the structures of CSR from the requirements placed by differing social interests and interests groups on the economic enterprise, in which the internal approach is left behind. It is not the contribution of a resource that determines to whom managers owe their obligations, but society’s interest in the firm’s success.

However, this approach stresses the multiplicity of social interests, without offering theoretically based criteria for normatively distinct interests. Pluralist approach frees company law from one-sided interest ties, but creates new problems of orientation. It needs direction from a theory that places the legitimate social function of the firm at the centre of the discussion and which selects those social groups with legitimate interests claiming such legitimacy.

Guidance mechanisms: morality versus law: second issue refers to social mechanisms which promote CSR. One group of authors focuses on external legal control, where it is the political process that defines society’s expectations for the scope of CSR in terms of legal norms, while another group focuses on internal moral controls, a kind of economic morality or code of ethics that guides management’s action toward socially responsible behaviour.

It is easy to criticize the latter theory because the wish to control societal structural effects of corporate activity by relying upon the individual decisions made by managers acting in a socially-responsible manner is economically inefficient, politically elitist and legally uncontrollable. This morally-based conceptual scheme also necessitates choices between morals and law. One does not need to make a choice between morals and law, but instead utilize the law to compel firms to behave morally and take account of the social consequences of their actions.

The role of the law: facilitation, regulation or stimulation: related to the issue of morality versus legality is the question of what role the law can play in a social institutionalization of CSR. Either the law is perceived in its regulatory functions (defining standards of business conduct and production and enforcing those standards via negative or positive sanctions) or perceived in its facilitative functions. By granting legal autonomy to strategic pursuit of private interests, law facilitates the development of market structures within which social responsibilities might develop.

Law should be used for indirectly controlling internal organizational structures through external regulation. The role of law then is not the external control of the firm’s conduct but external mobilization of internal self-control resources.

Function of CSR: coordinating the corporation with its environment CSR is at odds with principles of economic rationality and profit-maximization. It is Teubner’s thesis that the function of CSR can be understood only in terms of differentiation and

integration of society. CSR serves as one among several integrative devices in a society which is characterized by extreme functional differentiation.

Functional differentiation requires a displacement of integrative mechanisms from the level of society to the level of subsystems, which have to stand in a meaningful relationship to the functions of other subsystems.

CSR seems to be a decentralized integrative mechanism that places restrictions on economic action in the interest of other subsystems. Its function is social integration.

CSR serves as a decentralized integrative device between the autonomous economic organization and its environmental systems.

To support this thesis, there are distinctions between three systems of reference: function concerns the relationship of the subsystem to the whole system; performance concerns the relations of the


subsystem to other subsystems; and reflection concerns the relationship of the subsystem to itself. What is necessary is a precarious balancing of function and performance of the enterprise. The

balance cannot be produced from the outside through governmental economic policy or legal regulation. Only externally stimulated reflexive action within the functional subsystem itself can solve the problems of mediation. In this view, responsible corporate behaviour is characterized by contradictory demands of performance and function, which can only be resolved by externally stimulated internal reflexion.

Key concepts of fiduciary duty and of organizational interest should be oriented towards this dual requirement.

Functionalist answers to open questions What follows from functional approach to CSR? Beneficiaries: social groups are replaced by social functions; it is the function and structural

achievements of environmental subsystems which must now be seen as the beneficiaries of CSR. Mechanism: different guidance mechanisms needed to impose internal restraints on economic action

which has detrimental effects on the non-economic environment, meaning that institutions and procedures should be designed to promote internal reflexion on the basis of economic self-restraint. Fiduciary duties and organizational interests must be directed towards the creation of organizational structures for such discursive unification processes as to allow the optimal balancing of company performance and company function.

Role of law: law’s role is to promote these internal reflexion processes. The main function of law would be to substitute outside interventionist control for an organizational conscience that would reflect the balance between its social functions and its environmental performance.

Doctrinal consequences: proceduralization of fiduciary duties The law withdraws from detailed regulated and formulates an expanding business judgment rule,

focusing only on extreme cases of power abuse. Fiduciary duties ought to be recharacterized in the form of procedural and organizational norms.

Duties and liabilities should be developed in the direction of functional approach: as an integrative device concerning environmental relations of enterprise and secondarily, the internal political process of competing interest groups.

Substantive standards of fiduciary duties need to be replaced by procedural standards and organizational devices which guarantee the rationality of the interest-weighing process. Fiduciary duties should be transformed into duties of disclosure, audit, justification, consultation, and organization of internal control processes.1. Duties of disclosure: disclosure cannot be unlimited and its scope and limits must be defined. In

Germany, with the introduction of labour participation, the duty of adequate disclosure has been expanded into labour problems. In the U.S. with the emergence of union representation on corporate boards, there is an attempt to define access to information for union representatives in terms of fiduciary duties. Expansion of informational duties in areas outside of the corporation has taken place only marginally. But courts have developed impressive body of “duties of loyal information” which can be interpreted as fiduciary duties of corporations in a broader sense.

2. Duty of audit: authentic auditing requires systematic presentation of data with active public scrutiny and here, procedural fiduciary duties have their place in defining scope and depth of information required. In Germany, the movement towards a social audit tends to broaden fiduciary duties in terms of responsibility for social consequences. In the U.S the SEC adopted a modest approach which requires disclosure only with respect to non-compliance with environmental standards, but there is also a range of disclosure requirements implied from existing regulations. SEC’s approach may not be the correct one for expanding social fiduciary duties, thus, it might be advisable to use a direct “society approach” as in Europe.

3. Duties of justification, consultation and negotiation: a range of fiduciary duties can be unfolded which limit managerial autonomy by specific procedural requirements. Management may be under a legal obligation to involve boards, committees, etc. in decision-making. The


fulfilment of these duties depends on sanctions available to the institutions involved. There is a need for enforceable fiduciary duties. Many controversies have arisen about the duty of cooperation. In Germany, there is a duty of trustful cooperation and a duty to further the interests of employees and the enterprise. The duty to cooperate with institutions outside the corporation is an unexplored area. Only recently in CSR discussion have policy considerations envisaged duties of consultation with organized outside interests.

4. Duty to organize: a different type of procedural fiduciary responsibility would demand they very creation of certain institutions. In large, complex organizations, top management cannot possible be made responsible for all problems, but the idea is that management can be made responsible for creating a system of coordination and control. In German tort law, courts could not make the top of the organization liable, so courts created Organisationspflichten, whereby the leadership of the organization can be held liable because it had not designed an adequate organization of production and control. The concept should be transferred to our field of fiduciary responsibility.

Generalizations We can see different directions for fiduciary duties. Specification: the identification of a particular social problem and the creation of a solution

mechanism designed for the purpose with specific powers, decision-making procedures, and standards of liability. This reflects change from an interest-group approach to problem-oriented, functional approach.

Inclusion of the whole corporate structure: suggests that all corporate bodies and levels of hierarchy should be taken into consideration, with attention paid to participatory rights, decision-making procedures, liability standards, and information provisions.

Generalization of company law mechanisms: examine the whole, historically developed machinery of shareholders’ interest protection to see if it can be generalized in direction of broader social requirements. Practices of participation in decisions, standards of responsibility, liability and control arrangements, and court procedures to be reconsidered to see if they can be made use of to promote social responsibility.

Relation to the company constitution: responsibilities of management no longer bound by specific substantive duties, but by process of “constitutionalization,” which creates a network of decision procedures, institutional arrangements, and organizational units. These are the modern emanations of fiduciary duty as a legal principle. Fiduciary duties as specific norms remain important but now serve as devices of situational integration within the complex network of company constitution.

Chapman, Bruce "Trust, Economic Rationality, and the Corporate Fiduciary Obligation", 43 (1993) University of Toronto Law Journal 547

The restructuring of corporations affects employees, corporate clients, members of the community in which the corporation is located, yet few have a say about the running of the corporations that affect us so much.

It’s not at all clear that we should have a say But sometimes the burdens seem especially severe and concentrated, and particular stakeholders

feel a sense of betrayal It could be argued that this sense of betrayal is misplaced, and these stakeholders have only

themselves to blame. If they had special concerns, they should have contracted for the necessary protections in advance

But this argument rest on the view of the corporation as a “nexus of contracts” This paper challenges the contractual view of the corporation Competitive corporate contracting cannot achieve all that the “nexus of contracts” view promises,

unless it is aided by the very value that a contractual understanding of the fiduciary obligation denies, namely, the duty of loyalty and trust

Without trust, even efficient wealth-maximizing corporate contracting can make us all worse off


The concept of trust presents a deep challenge to the contractual model of corporations, and the conventions of instrumental rationality upon which the model is based

Trust, money and the Pareto principle If A wants what B has; B wants what C has; and C wants what A has, assuming there can only be

bilateral exchanges, there’s no way that everyone can get what they want unless there’s trust between the parties, or there’s money that can be trusted not to lose its value.

More generally, for some configurations of individual preferences, and some initial endowments, efficient exchange will only effect a Pareto-optimal outcome if either money can be trusted to retain its value, or some individual can be trusted to make what, on the economic model at least, is an irrational choice not to maximize her preferences

Kaldor-Hicks-efficient exchange and the Pareto principle Kaldor-Hicks efficiency criteria: goods are to be allocated to those whose willingness to pay for

the goods is greatest; but there is no need to pay compensation to those against whom the reallocation is made to ensure that they are not made any the worse off by it (that’s how it’s different from Pareto-optimality)

The best that can be hoped for in K-H efficiency is that a sufficient number of K-H efficient reallocations over time lead to everyone being able to reasonably expect ex ante to come out ahead.

This is the general argument that justifies the imposition of competitive harms, or pecuniary externalities; displaced competitors are simply those individuals who were unwilling or unable, to pay as much as some other party in the relevant auction that took place for some scarce resource.

K-H efficiency does not secure individuals against losses, but rather increases total wealth and, therefore, everyone’s ex ante prospects for a welfare gain after a sequence of such K-H reallocations have been completed

This could lead to the optimal result for the example with A, B, and C. Although each bilateral transaction (forced) produces a loser, overall everyone’s better off.

In some situations, though, forced K-H transfers can lead to an outcome where every individual is worse off than when she started. (If the gain to the “winner” in the transaction is smaller than the loss to the “loser” in the transaction)

The problem described above cannot happen if compensation is paid to those who lose out from K-H reallocations. Providing compensation turns K-H exchanges into Pareto-optimality exchanges

Voting cycles and contractual cycles in corporate law The problem of cyclical majorities: arises when each and every option selected by a majority vote

can in turn be defeated by another majority coalition More generally, this problem of social choice also surfaces in the context of competitive

corporate contracting Some authors suggest that it’s therefore necessary to restrict voting, or voice in corporate

governance One way to solve this problem: fiduciary obligations (i.e. firms managed for their workers, not

firms managed by their workers)Conclusion

Trust and institutional loyalty play a larger role in the corporation than the usual economic analysis allows

This is evidenced by the central role of fiduciary duties

February 17, Class 13: For what range of stakeholders are corporate fiduciary obligations recognized and protected?Informed by public choice theory, Macey and Miller take a critical approach to the extension of corporate liability


to a broad range of "stakeholders" You should consider their views critically and imagine what the counter-arguments are in support of expansive protection of stakeholders.

Macey, Jonathan R. and Miller, Geoffrey P. "Corporate Stakeholders: A Contractual Perspective", (1993) 43 University of Toronto Law Journal 401

this entire article is premised on the idea that corporations are “not an entity at all but a set of contracts or series of bargains” (347)

fiduciary duties are a corporate asset that will be bargained for and auctioned off among various groups of stakeholders. Fiduciary duties are more valuable to any given group if they are the only group to which such duties are owed. Otherwise, fiduciary duties are too diffuse to be really useful.

The recent regulatory trend of creating “Other Constituency Statutes” (a.k.a. “stakeholder statutes”) that forces directors to expand the scope of their fiduciary duties makes shareholders and other stakeholders less well off.

there are three general criticisms of stakeholder statutes:1) fiduciary duties should flow only to residual claimants (i.e. shareholders) because the residual

claimants have the greatest incentive to maximize the value of a corporation, and therefore place the highest value on the legal protection afforded by fiduciary duties.

- while this provides support for shareholders having exclusive access to the fiduciary duties, it is insufficient to explain when they should have exclusive access

- Still, shareholders should have exclusive access because all groups ultimately benefit from a legal regime that makes shareholders exclusive beneficiaries of fiduciary duties.

- the “web of contracts” perspective means that no class of participants has the right to view themselves as the “owners” of the firm per se; however, as suppliers of equity capital shareholders have a capacity for risk-taking and an interest in the overall profitability of the firm which is generally lacking in creditors, managers, and employees. This contrasts with creditors and managers who are “fixed claimants” wanting only to see their specific claims repaid. STILL, this doesn’t explain why the interests of other claimants shouldn’t be respected.

- ANSWER: 1) fiduciary duties are not public goods; 2) shareholders place the highest value on fiduciary duties and will therefore they will bargain and pay for the right to have exclusive access to these rights (which will benefit the other claimants).

2) constituency statutes require corporate agents to serve too many masters, which leads to confusion and misunderstanding on the part of courts and litigants which outweighs any potential benefits that such statutes might provide.

- this is the most common argument. It is a particularly acute problem when directors act quickly: “When directors must not only decide what their duty of loyalty mandates, but also to whom their duty of loyalty runs (and in what proportions) poorer decisions can be expected.” (349, citing ABA Section on Business Law)

- these statutes allow directors to justify virtually any decision, on the grounds that it will benefit some constituency (paying no regard to the deleterious effects it might have on other constituencies).

- the Corporate Law section of the ABA summarizes the current law emerging from the Delaware Supreme Court as follows: “[D]irectors have fiduciary responsibilities to shareholders which, while allowing directors to give consideration to the interests of others, compel them to find some reasonable relationship to the long-term interests of shareholders when so doing. In Delaware, this principles is modified when the decision is made to sell the company, at which time the directors may consider only the interests of shareholders.” (351)

- it is also important to note that over a wide range of issues, there is no conflict between the interests of shareholders and other groups


- following credit lyonnais Bank Nederland NV v. Pathe Communications Corp it is clear that as a corporation approaches insolvency, the shareholders’ interests become less relevant and the non-shareholder constituencies take on all the characteristics of residual claimants

3) constituency statutes fail to recognize that fiduciary duties are owed solely to residual claimants because they are the groups that faces the most severe set of contracting problems with respect to defining the nature and extent of the obligations owed to them by officers and directors.

- fiduciary duties should be seen as a method of gap-filling in incomplete contracts between the shareholders and the corporation

- non-shareholder groups can contract for various rights (e.g. vetoes on certain corporate transactions) and just because they have not done so does not mean that they couldn’t – merely that they weren’t willing to pay for it.

- in interpreting contracts with other groups, modern judges employ “gap filling” that serves essentially the same function as fiduciary duties do for shareholders: “An impressive literature on relational contracts indicates that modern judges should and do go a long way towards filling in unstated terms and conditions in long-term relational contracts such as those forged between non-shareholder constituencies and public corporations… thus non-shareholder constituencies (with the exception of local communities) already enjoy a substantial degree of protection of the gap-filling sort.”

- if add fiduciary duties to this, then you are actually shifting the legal analysis away from the actual contract between the parties. This leads to the potential shift of wealth away from shareholders, in unpredictable ways, which will reduce incentive to invest (and therefore societal wealth as a whole) in general.

local communities – municipalities can contract with firms to dictate the terms in which the firm will locate and operate in a community, however, this doesn’t always happen. Even if there is no previous express/implied agreement the authors think that “creating an amorphous, open-ended fiduciary duty running from the firm to the local community in which the firm operates is a singularly bad idea.” This is because this puts private, unelected business people in the place of public servants. They are completely unaccountable, cannot be impeached by the community. Furthermore, this is effectively a decision about how to allocate wealth within society.

conclusion – in situations where “other constituencies” have no meaningful stake in a particular decision, it is not constructive to extend fiduciary duties to them. There is no suitable alternative to fiduciary duties to protect shareholders interests. Allowing them exclusive access to fiduciary duties simply means giving them “a level of judicial protection commensurate with the nature of the firm’s contractual obligations to them.” (355)

PART 5: CORPORATE GOVERNANCE: ECONOMICS, MANAGEMENT AND COMPARATIVE LAW PERSPECTIVES ON THE LEGITIMATION OF POWER IN THE CORPORATION

Parallel VanDuzer Readings: Chapters 6 & 7 March 1, Class 14: What is the relationship between corporate fiduciary obligations and corporate governance?Fukuyama makes the argument that trust is crucial to strong economic performance. Jensen and Meckling discuss how firm ownership structure and firm governance should respond to the problem of agency costs, which in turn is linked to fiduciary responsibility in the firm.

Fukuyama, Francis Trust – The Social Virtues and the Creation of Prosperity, 17 (1996) A Free Press Paperbacks Book, 195


The network as a community based on reciprocal moral obligation is perhaps most fully developed in Japanese keiretsu. There are two categories of keiretsu:1. Vertical keiretsu: consists of a manufacturing firm, its upstream subcontractors and suppliers,

and its downstream marketing organizations.2. Horizontal keiretsu: more common, unites widely differing types of business.

A typical intermarket keiretsu is centered around a large bank or other financial institution, and usually also includes a general trading company, insurance company, etc. The keiretsu members have no formal legal ties though they come to be linked to on another through complicated system of cross-shareholding of each other’s equity.

Features of keiretsu:1. They are very large and play an important role in Japanese economy as a whole.2. Despite size, individual member companies seldom occupy monopoly position with regard to any

single sector of Japanese economy.3. Network members tend to trade with each other on a preferential basis, even paying higher prices

for the goods over foreign imports. This has been a major black for U.S.-Japan relations because U.S. cannot understand why they would do this!

4. Degree of intimacy that exists among keiretsu partners is very great and reflects great deal of trust. Info is shared because one party doesn’t worry that another party will misuse the info.

Firms integrate vertically in order to reduce transaction costs. They continue to expand until the costs of large size begin to exceed the savings from those transaction costs. The long-term relationships between keiretsu partners are a substitute for vertical integration and achieve similar efficiencies in terms of transaction cost savings.

Transaction costs that would be expensive to conduct across firm boundaries in a low-trust society like Hong Kong or Southern Italy cost much less in Japan because the contracting parties have a higher level of confidence that the contract will be fulfilled.

The intermarket keiretsu can share many of the transaction cost efficiencies of its vertical counterpart. The keiretsu played an important function in the 1960s and 1970s in blocking or controlling the

degree of foreign investment in Japan. As a result, few American multinationals were able to purchase more than minority interests in Japanese companies.

It is hard to imagine that the keiretsu could ever become a generalizable model, especially in low-trust societies. In a network, there is no overall source of authority. Consensus comes relatively easily in Japan, but in a low-trust society, the network form of organization would be a formula for paralysis and inaction. In Japan, this network functions because the degree of generalized trust among unrelated people is extraordinarily high.

Keiretsu relationships came under pressure during the recession that began in Japan in 1992. The recession caused small companies to find themselves occasionally unprotected by their keiretsu relationships as large manufacturers tried to cut their costs by pushing them onto subcontractors.

Pressure to break apart these relationships has also come from external sources, including American exporters eager to break into closed Japanese markets.

Japan was the first country in East Asia to move beyond family businesses to the modern corporate form, making use of hierarchical management structures and professional managers. Japan has been able to participate in a wide range of capital-intensive sectors. Japan has been successful because its society has a much stronger proclivity for spontaneous sociability than China or France. The radius of trust in Japan extends well beyond the family or lineage.

Jensen, Michael C. and Meckling, William H. "Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure" in Posner,

Draw on theory of (1) property rights; (2) agency; and (3) finance to develop a theory of ownership structure for the firm


Agency relationship: if both agent and principal are utility maximizers, the agent will not always act in the best interests of the principal

Agency cost (AC) to keeping monitoring the agent AC = monitoring cost + bonding expenditures + residual loss Residual loss is reduction in welfare experienced the by principal due to remaining divergence

between agent’s decisions and those that would maximize principal’s welfare Coase’s seminal paper: activities included in the firm whenever costs of using markets were

greater than the costs of using direct authority But we believe contractual relations are the essence of the firm, not only with employees but with

suppliers, customers, creditors etc. The problem of agency costs exists for all these contracts The corporation is a legal fiction which serves as a nexus for contracting relationships and which

is also characterized the existence of divisible residual claims on the assets and cash flows of the organization which can generally be sold without permission of the other contracting individuals

So it makes no sense to try to distinguish those things which are “inside” the firm from those things that are “outside” of it. There is only a multitude of complex relationships (i.e. contracts) between the legal fiction (the firm) and the owners of labour, material and capital inputs and the consumers of output.

The personalization of the firm implied by asking questions such as “does the firm have a social responsibility” is seriously misleading because the firm is not an individual

Agency cost: if the manager owns 95% of the stock of a corporation, he will expend resources to the point where the marginal utility derived from a dollar’s expenditure of the firm’s resources on such items equals the marginal utility of an additional 95 cents in general purchasing power (i.e. his share of the wealth reduction) and not one dollar

As manager’s ownership claim falls, his incentive to devote significant effort to creative activities such as serching out new profitable ventures falls

Competition from other potential managers (“market for corporate control”) limits the cots of obtaining managerial services

So why, given the existence of agency costs, is the corporate form, with widely diffuse ownership, so prevalent?

o Limited liability – but ordinary debt also carries limited liability…o The “irrelevance” of capital structure – because of bankruptcy and reorganization costs,

debt structure is dependent on the structure of the firmo i.e. the agency costs associated with debt are:

the opportunity wealth loss caused by the impact of deby on the investment decisions of the firm;

the monitoring and bonding expenditures by he bondholders and the owner-manager;

the bankruptcy and reorganization costso these costs are of concern to potential buyers of fixed claims in the firm

why are agency costs of debt incurred?o Tax subsidy on interest paymentso Generally: whenever the marginal wealth increments from the new investments project is

greater than the marginal agency costs of debt, and these agency costs are in turn less than those caused by the sale of additional equity, then debt’s the best way to go

March 3, Class 15: What are the legal contours of the problem of corporate governance?Corporate governance has to do with how power is deployed and controlled in the firm. These readings are designed to characterize the legal issues that are raised by the problem of corporate governance and to begin


placing this issues in comparative perspective.

Bybelezer, Henri M. "The ‘Corporate Governance’ Debate and Modern Theory of the Firm: Some Lessons", Corporate Structure, Finance and Operations – Essays on the Law and Business Practice, ed. by Lazar Sarna, (1988) Carswell, 53

“corporate governance” deals with issues of decision-making and accountability in public corporations. In modern corporations, characterized by the Berle-Means separation of ownership and control, this falls to professional managers (who are most suited to making these decisions because of their monopoly on information and proximity to economic pressures).

while some view this shift in intra-corporate power as value-neutral and inevitable (due to the “increasingly diffuse, isolated and uninformed nature of equity interests in the modern corporation”, 377) others consider the corporation, regardless of the locus of power, as a political entity which cannot be separated from the social context in which it operates. Proponents of the latter view argue that the particular ability of corporations to distribute wealth in society obligate it to do so in a “symbiotic” manner in society and to act as “a good citizen”.

author thinks that the main issue in current corporate governance stems from the gap in existing legal rules (which are based predominantly on an out-dated 19th C model of the corporation) and modern theories of the corporation: “[A] hypothesis that is implicit, though never pursued normatively, in the literature… there exists a perceived dysfunction in our received neoclassical model of the corporation, which no amount of proposed remedial measures with regard to the board of directors can remedy.” (378)

“for liability rules to carry force and conviction, and thus transcend mere artifice, they need to be founded in rational, achievable expectations well grounded in corporate and commercial reality … the existing legal framework pertaining to intra-corporate fiduciary duties is unduly weighted in favour of shareholders… [this] no longer reflects the complexity of the contemporary economic setting.”

for single entrepreneur-owners and for owner/managers of small firms, it is possible to supervise, compensate and sanction personally the economic conduct undertaken by employees on your behalf. This is because in small companies it is possible for a single individual to collect, analyse and process the information required for successful operations.

Once firm size became too large for the “control capacity” of the owner, “a serious conceptual contradiction afflicted the legal model, which no longer corresponded with the organizational paradigm upon which the formulation hinged.” (380)

this resulted in decentralization, and management hierarchies “representing multiple vertical and horizontal foci of intra-corporate authority”. This results in overlapping centres of decision making, which indicates an erosion of the traditional authority of the owner-entrepreneur.

to analyze the internal dynamics of modern firms must go beyond outdated neoclassical model: “It is a mistake to confuse the firm of economic theory with its real-world namesake. The chief mission of neoclassical economics is to understand how the price system coordinates the use of resources, not to understand the inner workings of real firms.” (citing Demsetz, 381)

“The corporation, a specialized form of the firm… must be treated as more than merely a production function onto which is superimposed a profit-maximization objective.” (381)

“the 20th C Welfare State has gradually co-opted ever-increasing powers to makes those social and economic decisions that were once the preserve of individual, free-market actors is a centripetal political reality that non would doubt today. It reflects a conscious choice by society to balance efficiency against fairness in the effects of economic forces upon its strong and weak constituents… The key question becomes what effects, if any, such a broad societal phenomenon, if true, should have upon the corporation, a traditionally ‘economic’ instrument of social ordering.” (383)

Iwai, Katsuhito "Persons, Things and Corporations: The Corporate Personality Controversy and Comparative Corporate


Governance", (1999) 47 American Journal of Comparative Law The law speaks of a business corp as a legal person, as a subject of rights and duties capable of

owning property, entering contracts, etc. At issue in this paper are two questions:1. Is a corp a real entity with its own will and purpose in society or merely an association of real

individuals forming a contract among themselves?2. Is its legal personality a truthful representation of the underlying social reality or a fictitious being

breathing only in the province of law? Two competing legal theories of the corp have emerged. Corporate realism holds that corp is an

organizational entity whose legal personality is not more than an external expression of its real personality in the society. Corporate nominalism holds that the corp is a contractual association of shareholders whose legal personality is no more than a way of writing their names together for transactions.

Both theories claim to have superseded the fiction theory, which maintained that the corp is a separate and distinct social entity but that its legal personality is a mere fiction created by state or law.

The debate was declared dead in the 1920s and the present article is a fresh attempt to end the debate by arguing that “person” signifies what law makes it signify.

The corp plays a dual role of person and thing and it is this duality that is responsible for the endless corporate personality controversy.

First objective of article is to explain the legal mechanisms through which the legal concept of corp can generate two contradictory corporate structures: corporate realism and corporate nominalism.

Second objective of article is to show that capitalism differs from country to country and that stark difference between U.S. and Japanese views on the purpose of the corp are but two variants of the genus Capitalism and are not contradictory. Law supplies the menu of legally possible corporate structures and each society chooses from this menu. U.S has chosen near the nominalist pole, while Japan has chosen near realist pole.

Third objective of article is to suggest how two views of organizing (organizations as collectivities rationally constructed to attain given purposes and as collectivities autonomously striving to reproduce themselves) correspond to nominalistic and realistic dichotomy.

There is no single corporate structure. The foundation of every corporate governance system lies in managers’ fiduciary duties to the corp and legal rules regulating these duties should be mandatory.

Corporation as a person/thing duality The corp as a “person” legally owns assets. A corporate shareholder owns the corp as a thing. An

incorporated firm is compose of two ownership relations: shareholders own the corp and the corp in turn owns the corporate assets. Legally, it is endowed with personality and thingness.

Past controversy on the nature of the corp has focused on its legal personality, but it is the person/thing duality that is responsible for the confusion regarding the corp’s essence.

Meir Dan-Cohen suggests image of corp as a machine endowed with artificial intelligence to capture the inherently irreconcilable person/thing duality.

How to make a nominalistic corporation To eliminate personality from a corp, have someone buy more than 50% of its shares then command a

majority block of votes and acquire absolute control over the corp, which is then deprived of its subjectivity and turned into a mere object of property right.

Example of corporate raider trying to organize a takeover bid. The day-to-day business of a corp raider is an attempt to eliminate the personality from person-cum-thing corps and restore the simple person-cum-things relation of the classical firm. Corporate raiders appear to help realize the idea of corporate nominalism in the world.

But does this mean that the existence of corporate raiders has settled the debate in favour of corporate nominalism? No, because corporate realism can be achieved as well.


How to make a realistic corporation Fundamental premise of civil society is that every human is free. In system of law, a corp is treated

like a human. But it is also an object of property and can never be a self-determining subject. As a legal person, a corp can own things and as a legal thing, it can be owned by persons. Since 1889

when New Jersey recognized holding companies, corps all over the world have been buying and holding shares in other corps to combine horizontally or to integrate vertically. Holding company is created solely for purpose of owning other corps and thus acts as a person. But it still falls short of shedding its thingness because it has its own dominant shareholders watching over it.

Taking it further, a corp as a person can own itself as a thing. The self-owning corp eliminates humans as its owners, but this does not mean that it has eliminated all its owners. Since it is a legal thing, it is impossible for it to be ownerless, legally.

This comes close to paradigm of corporate realism. The claim of corporate realism is not only that a corp has legal personality, but also that this personality is an outer expression of the underlying social reality. This brings us to the relationship between law and society.

Two capitalisms U.S. assumption is that purpose of business corp is to maximize returns to its shareholders and that

the task of managers if to exercise their powers for that purpose only. Yet this assumption has no place in Japan or some European countries.

Survey showed that American corporate managers were consistent with assumption of primacy of shareholders’ interest, while Japanese managers placed capital gains of shareholders at the bottom of list.

In the U.S. it is believed that task of corporate managers is to maximize returns of shareholders, while in Japan, the manager’s job is to seek the survival and growth of the corp itself.

This dichotomy, called the “shareholder capitalism” versus “corporate capitalism” is a simplification. There is disparity and fluctuation within each type of capitalism. In Dodge v. Ford Motor Co. (1912), Michigan Supreme Court confirmed the traditional assumption of the supremacy of shareholders’ interests. Other swings took place in the 1930s and 1990s, leading to the enactment of state statutes instructing corporate directors to take account of interests of constituencies other than shareholders.

In Japan, there is a swing in the opposite direction. Disgusted by scandals, alarmed by recession, academics, business leaders, etc. have brought pressure to change inflexible system to become more like the Americans.

But these two seemingly contradictory capitalisms are two extreme forms of Capitalism. From the long legal menu, the American and Japanese economies have chosen their dominant corporate structure, one close to the nominalistic end and one close to the realistic end, respectively. They have been chosen along a long continuum of possible corporate structures and the law has supplied each society a menu to choose from.

Corporation vs. organization What is the purpose of the corp? In the case of the nominalistic corp, it is to maximize the returns to

its shareholders. If there is such a thing as purpose for the realistic corp, it should refer to the purpose of some social entity that lies beneath the personality of the corp.

Each corp needs an organization to make use of its own assets in society. It is a legal requirement that a corp must have a board of directors who hold the formal powers to act in the name of the corp.

The classical conception of organization is that of an instrument, for the explicit purpose of attaining a specified goal. This is consistent with the nominalistic view of corps, thus a nominalistic corp is a mere means for its dominant shareholders.

Two different conceptions of organizations: one emphasizes their instrumental nature the other their autonomous nature. These two opposing concepts are not incompatible but are valid representations


of their two polar empirical types.

Fiduciary principles in the system of corporate governance Picture of business corp cannot be complete without having managers. Evaluates agency relationship and concludes that relation between shareholders and managers can no

longer be identified with an agency relation. Shareholders are in no sense in charge of the directors of their corp.

Corporate directors are not the agents of their shareholders, but rather, they are the fiduciaries of the corp. The fiduciary is a person entrusted to act as a substitute for another person for the sole purpose of serving that person.

In the case of corporate directors, the law endows them with powers to act as the corp rather than merely to represent the corp as its agents.

This leads to the central problem of corporate governance: the abuse of fiduciary powers. The risk that the powers will be misused stems from nature of the corp as a legal person and the line between the use and abuse of fiduciary powers is very thin.

So how to prevent them from transgressing this line? He argues that at the foundation of the corporate governance system lies the corporate managers’ fiduciary duties to the corp and that legal rules regulating these duties should be mandatory.

Most conspicuous feature of fiduciary law is its moralistic tone. Courts impose duties that specify the standards of judging the trustworthiness and fairness of decisions and transactions made which may conflict with best interests of corp (including duty of care, disclosure, prohibition of self-dealing and insider trading, etc.).

Although advocates of contractual theory of the firm argue that participants in the corporate contract ought to be free to opt out of existing rules if they feel they can strike a better bargain among themselves, the author says this is untenable. Fiduciary law can never be substituted for the private order. To make corporate law enabling and permit its fiduciary rules to be bargained around by insiders would destroy the corporate governance system.

But luckily the tradition of fiduciary law is hostile to viewing the fiduciary rules as implicit contracts.

Supplementary corporate governance mechanisms and corporate veil piercing It is not wise or practice to rely solely on fiduciary law for governance of business corps.

Implementation of such law requires a well-organized legal system and active courts. Even if course are active, the implementation of fiduciary law would demand a large amount of resources, especially since the business judgment rule very often works as a barrier to its applications unless courts are presented with very strong cases.

It is vital to supplement fiduciary law with other governance methods. And it is as the agents of these supplementary mechanisms that the shareholders as well as other stakeholders, such as banks, employees, suppliers, and customers, find their roles to play in the system of corporate governance.

There is wide variation in these supplementary mechanisms in different countries. To protect creditors from fraudulent transfers, the courts sometimes pierce the corporate veil and

subject the dominant shareholder to personal liability for the debts of the corp.

Concluding remarks Japan has able to develop a highly realistic corporate system, but now that its economy has overtaken

most of the advanced Western economies both in size and efficiency, it can no longer act as a small country and is exposed to global capitalism.

Rapid liberalization of financial markets in 1990s is said to have weakened the traditional ties between banks and industrial firms and have begun to loosen the tight networks that have shaped the realistic feature of Japanese corporate system.

However, most of the Japanese corps are likely to remain highly realistic for the time being, but the current tide is certainly in the nominalist direction, given the advancements in technology and the


expanding global markets.

Blair, Margaret M. and Stout, Lynn A. "A Team Production Theory of Corporate Law", (1999) 85 Virginia Law ReviewIntroduction

Take issue with principal-agent model of the public corporation and the shareholder wealth maximization goal that underlies it

We think the team production approach goes much further in explaining both the distinctive legal doctrines that apply to public corporations and the unique role these business entities have come to play in American economic life

Shareholders are not the only group that may provide specialized inputs into corporate production; executives, employees, creditors, the local community may contribute

The law of public corporations allows opting into an internal governance structure, the “mediating hierarchy,” which requires that team members give up some rights (e.g. property rights over the team’s joint output) to a legal entity created by the act of incorporation

Control over assets is exercised by internal hierarchy; at the peak of the hierarchy is the board of directors

How can widely dispersed shareholders in public corporations make sure directors use their authority to further shareholders’ interests?

Because: the board exists not to protect shareholders per se, but to protect the enterprise-specific investment of all members of the corporate “team,” including shareholders, managers, employees and possibly others

I. Economic Theories of the CorporationA. Conventional Economic Analyses of the FirmWhy do firms exist? Post-Coase, three main paths the literature has taken, each focussing on a different aspect of organizing productive activities:

Principal-agent problem Property rights approach: using property rights to fill contractual gaps Role of hierarchy – the team production approach (authors think is best!)

B. Team Production Analysis of the Firm Team production: production which (1) several types of resources are used; (2) the product is not

a sum of separable outputs of each cooperating resource; and (3) not all resources used in team production belong to one person

How to design incentives to avoiding shirking responsibility (free-rider problem) (arises if agree in advance on how to allocate profits); and also avoid rent-seeking behaviour (arises if agree to allocate rewards after the fact)

One way: team members can relinquish control over both the team’s assets and output to a third party, the “mediating hierarch,” whose primary function is to exercise control to maximize the joint welfare of the team as a whole

o Emphasizes that individuals will want to be part of a team only if they can share in economic surplus

o Recognized that team members intuitively understand that it will be difficult to convince others to invest firm-specific resources in team production if shirking and rent-seeking go uncontrolled

o In other words, team members submit to hierarchy not for the hierarchy’s benefit, but for their own.

In reality, corporations are not so much a “nexus of contracts” as a “nexus of firm-specific investments,” i.e. several different groups contribute unique and essential resources to the corporate enterprise, in the hopes of sharing in the benefits that can flow from team production, and each find it difficult to protect their contribution through explicit contracts, so each is vulnerable to opportunistic exploitation by other team members


C. The Public Corporation as a Mediating Hierarchy Forming a corporation is creating a mediating hierarchy First step: Board of Directors – ultimate decision-making authority Why do they do this? Tam members understand that they would be less likely to elicit the full

cooperation and firm-specific investment of other members if they did not give up control rights

A public corporation is a team of people who enter into a complex agreement to work together for their mutual gain

Mediating hierarchy replaces explicit contracting: especially useful when various kinds of investments in projects are complex, ongoing and unpredictable

If a team member leaves, they lose the value of their firm-specific investment and can no longer share in the residual rents generated by the enterprise

Important to recall that the goal of corporate law is not to protect shareholders’ interests, but to protect stakeholders’ interests. How the Board allocates rents among the various stakeholders is discretionary (to a point: business judgement rule), and depends on markets

II. A Team Production Analysis of he Law of Corporations Derivative suits (in some circumstances shareholders can sue the Board on behalf of the

corporation) and shareholder voting rights have been viewed as evidence of shareholder primacy We disagree. Directors serve “the corporation” and not just the shareholders “the corporation” is made up of all individuals who make firm-specific investments and agree to

participate in the extra-contractual, internal mediation process within the firm (i.e. ultimately have to obey the Board)

Shareholders have some voting rights and can launch derivative suits because they’re in the best position to represent the coalition that comprises the firm.

A. Directors’ Legal Role: Trustees More than Agents Rules of agency: an agent owes her principal a “duty of obedience,” i.e. principal has control over

agent The Board has no legal obligation to obey shareholders. Shareholders can elect directors and,

under some circumstances, remove them; but they cannot tell them what to do (shareholders can’t, say, force the Board to declare a dividend)

Directors are a unique form of fiduciary, who resemble trustees: ultimate decision-making authority subject to fiduciary duties

This fits with our hierarchy modelB. Corporate Personality and the Rules of Derivative Procedure

Corporation as “person” a new legal entity Derivative suit: in theory, Directors owe fiduciary duties to the corporate personality. If a

director violates her fiduciary duties, any claim brought must be brought by the corporation. But problems arise when the Board is asked to bring a claim in the firm’s name for injury suffered at the hand of the Board. Under the derivative suit rules, when a majority of the Board charged with taking legal action on behalf of the firm has conflicting personal interest, a shareholder may, under very limited circumstances, step into the shoes of the corporate entity and sue in its name and on its behalf.

This is designed to serve the interests of the corporation as a whole, not those of the shareholders This fits with our mediating hierarchy model:

C. The Substance of Directors’ Fiduciary Duties Duty of loyalty: has been interpreted narrowly to encompass two things: (1) self-dealing; and (2)

directors taking a “corporate opportunity” by reaping profits from personal business ventures that either are in the same line of business as the firm’s or became available to them because of their corporate position

Duty of Care, Business Judgement Rule, and Best Interests of the Corporation: duty of care to the firm has, in practice, been largely eviscerated by the business judgement rule


o Business judgement rule: important: prevents coalition members from using lawsuits as strategic devices to extract rents from the coalition

o Applies when decision was (1) informed; (2) honest; and (3) honestly thought to be in best interest of the company.

o Dodge v. Ford Motor Co (1919): the Dodge brothers, minority shareholders of Ford, sought to compel the highly profitable company to pay out a large dividend. The Board resisted, in response to Henry Ford’s demand that the company’s huge profits be used to create more jobs by expanding production and to benefit consumers by reducing Ford’s car prices. Judgment came down firmly on the side of the shareholders

o BUT the caselaw has evolved since 1919, in a direction that disfavours the shareholder primacy view: caselaw interpreting the business judgement rule often explicitly authorizes directors to sacrifice shareholders’ interests to protect other constituencies

Director Adoption of Takeover Defenses and Other “Mixed Motive” Caseso The pursuit of directors’ nonmonetary interest in mixed motive situations often benefits

other stakeholders in the firm, even as it harms shareholders (e.g. retaining corporate earnings instead of paying a dividend; resisting a hostile takeover that would increase stock value)

o The hostile cases in Delaware: Unocal Corp. v. Mesa Petroleum: rejects shareholder primacy in favour of the

view that the interest of the “corporation” include the interests of nonshareholder constituencies

Revlon v. MacAncrews & Forbes: the directors adopted defensive strategies that favoured a friendly bidder over a hostile bidder ,citing a desire to protect certain creditors. Court held that “when break-up of the company inevitable, the duty of the board changes from the preservation of Revlon as a corporate entity to the maximization of the company’s value of stockholders”

D. Reexamining Shareholders’ Voting Rights Two types of shareholder voting rights:

o To elect (and sometimes remove) Directorso To vote on certain “fundamental” corporate changes

But in publicly held firms with widely dispersed share ownership, legal and practical obstacles to shareholder action render voting rights almost meaningless

Arguably, having shareholders vote serves the interests of all stakeholders: someone has to appoint Directors

E. How Corporate Law Keeps Directors Faithful Directors want to keep their positions, and also want to maintain a good reputation if they hope to

ve invited to serve on additional Boards Since corporate law limits Directors’ ability to serve their own interests, they might as well serve

the corporation’s Corporate cultural norms of fairness and trust

III. Conclusion Our article does not reject the “nexus of contracts” view of the corporation, but builds on it by

acknowledging the limits of what can be achieved by explicit contracting “pactum subjectionis” under which shareholders, managers, employees and other groups that

make firm-specific investments yield control over both those investments and the resulting output to the corporation’s internal governing hierarchy

Corporate law is not designed primarily to protect the shareholders, but to protect the corporate coalition by allowing directors to allocate rents among various stakeholders, while guarding the coalition as a whole only from gross self-dealing by Directors


Economic advantages to the public corporation form because of the requirement of ceding control to an independent board of directors

Fundamentally political nature of the corporation: corporations mediate among the competing interests of various groups and individuals that risk firm-specific investments in a joint enterprise

Redirection of corporate wealth from employees to shareholders can be explained by changing market forces which altered various team members’ opportunity costs, and thus the minimum rewards they must receive to have an incentive to remain in the team.

March 8, Class 16: What light does the Management literature shed on the problem of corporate governance?

These readings are drawn from two of the leading contemporary management theorists and are designed to link the legal discussion of corporate governance with the perspective of firm management.

Mintzberg, Henry and Quinn, James Brian The Strategy Process – Concepts, Contexts, Cases, Prentice Hall, New Jersey, Ch. 7: Ideology and the Missionary Organization, 370.

Organizations are systems that produce more through the cooperative synergy of their members than the members could produce on their own. The intangible component that produces this effect through the participating individuals is the organization’s ideology. “[A]n ideology is taken … to mean a rich system of values and beliefs about an organization, shared by its members, that distinguishes it from other organizations. .. The key feature is its unifying power.” (446)

an organizational ideology is rooted in a common mission which can be anything from religious proselytizing to selling veggie burgers.

in new organizations, an exciting shared sense of mission is common for 4 reasons:1) there is no established institutional procedure/ tradition, so people can make things up2) orgs generally start small, which allows personal bonds between members of the group3) founding members often share a strong sense of beliefs4) founders of new orgs are often charismatic

it is possible to create new ideologies in old institutions, but much harder whether new/old org, a key to developing institutional ideology is “a genuine belief in mission and an

honest dedication to the people who must carry it out”. ideologies are developed over time through the creation of institutional history: “Gradually, … the

organization is converted from an expendable ‘instrument’ for the accomplishment of externally imposed goals into an ‘institution,’ a system with a life of its own. It ‘acquires a self, a distinctive history’.” (447)

institutional ideology is reinforced through identification between the individual and the institution. This may happen naturally, because the member identifies with the org’s goals; new members may be selected so that they will fit in; identification may be evoked through socialization or indoctrination; or it may be calculated on the part of the individual for some gain (e.g. remuneration).

missionary organizations are those that have strong ideologies; their members’ identification tends to be strong, natural, selected. The mission is typically clear, focussed, inspiring, and distinctive. The organization is held together by the sharing of values and beliefs among its members.

missionary organizations are held together by the sharing of values and beliefs of the members. These orgs can achieve the greatest degree of decentralization, but that doesn’t mean that there is no power structure. e.g. of kibbutz (see 449-50 for chart comparing principles of bureaucratic organization to principles of kibbutz organization).

Mintzberg, Henry and Quinn, James Brian The Strategy Process – Concepts, Contexts, Cases, Prentice Hall, New Jersey, Ch. 6, 331


Recent management theory has moved away from “one best way” approach toward “it all depends” approach. Structure should reflect the organization’s individual situation (e.g. its size, age, etc.).

This article argues that the “it all depends” approach does not go far enough and posits instead the “getting it all together” or “configuration” approach.

Six basic parts of the organization At the base of any organization is its operators, who form the operating core. All but simplest

organizations require a manager who occupies the strategic apex, where the whole system is overseen. A middle line is created, a hierarchy of authority between the operating core and the strategic apex.

When organization is more complex, it requires more people: the analysts, who perform administrative duties. They form the technostructure. Staff units of a different kind are also added: the support staff.

Each organization has its ideology or culture, which encompasses its traditions and beliefs. Those who work inside the organization are the internal coalition, and those outsiders who are

external influences, are the external coalition.

Six basic coordinating mechanisms Two fundamental and opposing requirements: division of labour and coordination of tasks.

1. Mutual adjustment achieves coordination of work by simple process of informal communication and it is used in simplest of organizations and most complex because it can only means that can be relied on in difficult circumstances.

2. Direct supervision is when one person coordinates by giving order to others and it tends to come into play when a certain number of people work together.

3. Standardization of work processes means the specification of the content of the work directly and procedures to be followed.

4. Standardization of outputs means the specification not of what is to be done but of its results.5. Standardization of skills is a looser way to achieve coordination, where the worker rather than

the work or the outputs that is standardized. The worker is taught a body of knowledge and skills which are then applied to the work.

6. Standardization of norms means that workers share a common set of beliefs and can achieve coordination based on it.

These coordinating mechanisms are the most basic elements of structure and the glue that holds organizations together.

Essential parameters of design The essence of organizational design is the manipulation of a series of parameters that determine the

division of labour and achievement of coordination. Listed below are the main parameters of structural design:

1. Job specialization is the number of tasks in a given job and the worker’s control over these tasks.2. Behaviour formalization is the standardization of work process by the imposition of operating

instructions, job descriptions, rules, and regulations.3. Training is the use of formal instructional programs to establish and standardize in people the

necessary skills to do particular jobs.4. Indoctrination refers to programs and techniques by which the norms of the members of an

organization are standardized, so that they become responsive to its ideological needs and can be trusted to make its decisions and take its actions. [AH: sounds like a cult!]


5. Unit grouping refers to the choice of the bases by which positions are grouped together into units. The bases can be reduced fundamentally to two: function performed and market served.

6. Unit size refers to the number of positions (units) contained in a single unit. 7. Planning and control systems are used to standardize outputs and may be divided unto action

planning systems and performance control systems.8. Liaison devices refer to a whole series of mechanisms used to encourage adjustment within and

between units. Four important ones are:i. Liaison positions are jobs created to coordinate the work of two units directly.ii. Task forces and standing committees are institutionalized forms of meetings that bring

members of different units together on intensive basis.iii. Integrating managers are liaison personnel with formally authority who provide for

stronger coordination.iv. Matrix structure carries liaison to its natural conclusion.

9. Decentralization refers to the diffusion of decision-making power

Situational factors A number of contingency or situational factors influence the choice of design parameters and vice

versa:1. Age and size

i. The older an organization, the more formalized its behaviour.ii. The larger an organization, the more formalized its behaviour.iii. The larger an organization, the more elaborate its structure.iv. The larger the organization, the larger the size of its average bargaining unit.v. Structure reflects the age of the industry from its founding.

2. Technical systemi. The more regulating the system, the more formalized the operating work and the more

bureaucratic its operating core.ii. The more complex the technical system the more elaborate and professional the support

staff.iii. The automation of the operating core forms a bureaucratic administrative structure into

an organic one.3. Environment

i. The more dynamic an organization’s environment, the more organic its structure.ii. The more complex an organization’s environment, the more decentralized its structure.iii. The more diversified its markets, the greater the propensity to split into market-based

units, given favourable economies of scale.iv. Extreme hostility in its environment drives any organization to centralize its structure

temporarily.4. Power

i. The greater the external control of an organization, the more centralized and formalized its structure.

ii. A divided external coalition will tend to give rise to a politicized internal coalition.iii. Fashion favours the structure of the day (and culture), even when inappropriate.

The configurations

Entrepreneurial organization The structure is simple and little of the behaviour is formalized and minimal use is made of planning,

training, or liaison devices. The structure is organic and has little need for staff analysts. There are few middle line managers because coordination is handled at top. Support staff also minimal to keep


organization lean and flexible. Classic case is small entrepreneurial firm, controlled tightly by owner.

Machine organization This is the offspring of the Industrial Revolution, when jobs became specialized and standardized. It

requires a large technostructure to design and maintain systems of standardization. A large hierarchy of middle line managers emerges to control the specialized work of the operating core. To enable managers to maintain centralized control, the environment and production system must be fairly simple. This fits best with mass production.

Professional organization This relies on standardization of skills for its coordination. The pull to professionalize dominates. By

relying on trained professionals, the organization renders a good deal of its power to the professionals and institutions that train them initially. The structure emerges as highly decentralized horizontally. There is little need for technostructure. Because professionals work independently, size of operating units can be very large and few first line managers are needed. Support staff is large. This is called for when an organization is in an environment that is stable yet complex.

Diversified organization This is like a set of independent entities coupled by a loose administrative structure. Each division

has its own structure. There is a limited form of decentralization down the chain of command.

Innovative organization This is an organization that relies for coordination on mutual adjustment among its highly trained and

highly specialized experts, which it encourages by the extensive use of the liaison device. The experts are grouped in functional units but deployed in small market based project teams to do their work. The structure becomes decentralized selectively, according to expertise and need. These organizations are found in complex and dynamic environments.

Missionary organization When dominated by an ideology, an organization’s members pull together, so there is a loose division

of labour and little job specialization. What holds it together is the standardization of norms and the sharing of values and beliefs. It has little technostructure. They tend not to be young organizations because it takes time for beliefs to become institutionalized. Neither the environment nor the technical system can be very complex.

Political organization When an organization has no dominant part, no mechanism of coordination and no stable for of

centralization or decentralization, it may become political, characterized by the pulling apart of its different parts.

Drucker, Peter F. The Changing World of the Executive, 6 (1982) Times Book, 31

Make sure the company has a top management competent to run the business. Board judges top management in four areas: allocating capital; performance in appointing people to managerial and other key positions; performance in respect to innovation; adequacy and reliability of strategic plans

Make sure top management itself is properly structure and properly staffed Make sure top management things through what business the company is in and what business it

should be in, and what business it should not be in Make sure top management thing through and set goals for the productivity of resources (physical

resources, people, time etc.)


Make sure the company has adequate policies for its key outside relationships: with government, labour unions, the public in general, and adequate policies with respect to its legal and regulatory responsibilities

Supervise the management of the pension fund Major debate: tradition of putting people on the board who render services to the company

(lawyers or underwriters) or who are retired executives of the company Before we can intelligently discuss how to staff the Board of Directors, we have to know what the

work and the assignments are. i.e. we have to determine the specific responsibilities of the directors and the work needed in order to discharge them.

March 10, Class 17: What does one learn from a comparison of leading domestic corporate governance regimes?The organization of corporate boards and the oversight of managers takes on a considerable variety of forms in different firms and different jurisdictions. The Maher and Andersson paper for the OECD presents a useful overview of various approaches. French, German, Japanese, South African, U.K. and U.S. models of corporate governance are discussed in the subsequent readings.While you should read these materials as a package, The first hour will focus on Anglo-American corporate governance models and the second hour will focus on their rivals.

Maher, Maria and Andersson, Thomas "Corporate Governance: Effects on Firm Performance and Economic Growth", 1999

I. Introduction Corporate governance can improve microeconomic efficiency affects dev’t and fcning of capital

markets and exerts strong influence on resource allocation, impacts behaviours and performance of firms, innovative activity, entrepreneurship, and dev’t of an active SME (small and medium-sized enterprise) sector, affects competitiveness of firms

Firms can be distinguished by degree of ownership and control, and identity of controlling shareholders:

Wide, dispersed systems (outsider systems): US, UK: basic conflict of interest is between strong managers and weak shareholders

Concentrated ownership or control (insider systems): Continental Europe, Japan: basic conflict of interest is between controlling shareholders and weak minority shareholders.

Can’t forget about context in which the corporation is functioningII. Analytical Framework: the Shareholder and Stakeholders Models of Governance

Corporate governance traditionally been associated with the “agency” problem (see Berle and Means) Useful to consider different analytical backgrounds often employed re: nature and purpose of the firm Shareholder and Stakeholder models are two endpoints of a continuum

a. The Shareholder Model Formal system of accountability of senior management to shareholders Objective of firm is to maximise shareholder wealth, i.e. maximize profits Agency problem: interests and objectives of principal (shareholders) and agent (managers) differ; also

“incomplete contract” view put forward by Coase, Jensen and Meckling, and Hart, i.e. agency problem would not arise if it were possible to write a full contract:

Hart: “Governance structures can be seen as a mechanism for making decisions that have not been specified in the initial contract”

Another consequence of agency: “hold-up” problem, i.e. investors aren’t willing to invest as much ex-ante in firms, leading to socially inefficient levels of investment, because of possibility of opportunistic behaviour by managers

So want a governance structure that minimizes agency cost and hold-up problems Note: for closely held firms, issues are different: not general shareholder protection issues, but how to

protect minority shareholders without disenfranchising the majority shareholderb. The Stakeholder Model


Takes a broader view of the firm Corporation is responsible to employees, suppliers, customers, creditos, and social constituents such

as membs of the community in which the firm is located, environmental groups, and society at large, as well as shareholders

Corps whoudl be “socially responsible,” and managed in the public interest Can also take narrower view of who is stakeholder, and include only those who have contributed

firm-specific capital Network of formal and informal relations involving the corporation

c. The interaction of corporate Governance with the Institutional and Economic Framework Argument can be made that we don’t have to worry about corporate governance since market

competition provides incentives for firms to adopt the most efficient corporate governance mechanisms. i.e. no need for external policy interventions

BUT market alone cannot sole the market failures arising from asymmetric information, hold-up, and principal-agent problems

It’s true that effectiveness and form of different corporate governance systems are influenced by product market competition, structure of capital and labour markets, and the regulatory and legal environments (i.e. there are interactions)III. Corporate Governance in OECD Countries: Strengths, Weaknesses, and Economic

Implications Two relevant dimensions: (1) ownership (e.g. % of equity) (dispersed or concentrated) ; (2) voting

rights (because not always 1-share-1-vote) (can be dispersed or concentrated)Dispersed Voting Power Concentrated Voting Power

Dispersed Ownership

Many small SHs1-share-1-voteImplications: strong managers, weak owners; takeovers are possibleUS, UK

Many small SHsVoting power concentrated in the hands of blockholders via dual class shares, golden shares, proxy votes, etc.Implications: strong voting blockholders, weak minority owners; takeovers are impossible

Concentrated Ownership

Large SHsVoting power of ownership diluted via capped votingImplications: strong managers, weak owners; takeovers are difficult

Large SHsVoting rights alighned with ownership rights via 1-share-1-vote, or concentrated via separation devicesImplications: weak managers, weak minority owners, strong majority owners; takeovers are possible

Patterns of voting power and ownership differ across countries Legal and regulatory environments both the cause and the effect of corporate governance

a. Outsider Systems of Corporate Governance Typical in US and UK Characterized by widely dispersed share ownership and high turnover Must strike balance between providing adequate shareholder protection and allowing investors to

assume risks as they see fit: disclosure req’ments Advantages: enhanced liquidity of stocks, and therefore better risk diversification for investors Disadvantages: because incentives to monitor management are weak, agency problem (corporate

governance can address this) US and UK: share ownership is characterized by the domination of institutional investors (mutual

funds, unit trusts wider diversification, pro management) Board of Directors is another low-cost monitoring device. Should be independent, but although the

Board should represent the shareholders, often it becomes part of the management of the corporation. Market for corporate control perhaps a much more effective disciplinary device than monitoring by

institutional investors or by the Board.


Focus on share value can be myopic: e.g. look to things that will do well in the short-term (e.g. applied R&D research), as opposed to things that may have high payoff, but only in the long term (e.g. basic, exploratory research): this hurts long-term economic growth

b. Insider Systems of Corporate Governance Typical of Continental Europe, Japan and Korea Concentrated ownership or voting power and a multiplicity of inter-firm relationships and corporate

holdings Holding companies, banks and familial control are dominant features Conflict: between controlling shareholders and minority shareholders (e.g. managers are often forced

to maximise “blockholder value,” and this does not necessarily maximize minority shareholders’ returns.

Advantages: concentrated ownership or voting power can overcome the problems with the monitoring of management, presumably positive benefits for firm performance, also encourages long-term relationships and commitment among stakeholders of firm-specific assets, greater trust, loyalty and commitment among stakeholders

Disadvantages: lack of liquidity, lack of opportunities for risk diversification, concentration may weaken the overall level of competition in product markets; complex patterns of cross-ownership that often arise between related companies in insider systems can result in collusive behaviour

Typically more emphasis on banks as providers of external finance: bank performs important monitoring and screening functions; on the other hand, emergence and survival of new firms is largely dependent on bank finance, which can be hard to obtain

c. A Convergence in Systems? Globalization of financial markets and increased liberalization of international trade seem to have

created an environment in which differences in corporate governance are becoming less severe, each system adopting some features of the otherIV. Corporate Governance and Performance: The Empirical Evidence

Do different corporate governance arrangements affect corporate performance or economic growth? Ownership concentration and firm performance Vast majority of empirical studies show that benefits of enhanced monitoring as a result of higher

ownership concentration outweigh the costs of this set-up (low diversification opportunities or rent extraction by majority owners)

a. Dominant shareholders and the expropriation of minority shareholders Evidence suggests that controlling blockholders receive private benefits at the expense of minority

shareholders Development of policies aimed at protection of minority shareholders may be particularly needed in

countries with relatively weak corporate governance or legal systems Challenging task facing policy makers is to design corporate governance frameworks that secure the

benefits of large shareholders as effective monitors of management while preventing them from extracting excessive private benfits of control (i.e. protect minority shareholders)

b. The market for corporate control and firm performance Outside US and UK, there are very few hostile takeovers The efficiency of takeovers as a disciplining mechanism is a controversial and somewhat unresolved

issue There are incentives other than improving efficiency for taking over another corporation: managers

want to have a bigger company (so take over another one), changes in corporate strategy Some argue that mere threat of a takeover serves as great disciplining device, and there is evidence to

support thisc. Managerial compensation and firm performance

How to provide incentives to induce managers to act in the interest of shareholders (i.e. maximize profits)? Can tie compensation of managers to the performance of the firm


There are substitute effects between direct monitoring by owners and compensation incentives (i.e. in places where there is less direct monitoring, managers’ incentives are more tied to firm performance and vice versa)

But have to be careful: this can be abused – e.g. timing stock option awards so they coincide with favourable movements in company stock prices, short-termist behaviour exacerbated, managers issuing debt and using the debt to buy back equity

Conclusion: use of share and share options must be more closely linked to performanceV. Conclusions

Corporate governance affect the dev’t and fcning of capital markets and exerts a strong influence on resource allocation; also affects industrial competitiveness and economies of countries

One of most striking differences between countries’ corporate governance systems: difference in the ownership and control of firms that exist across countries

There are tradeoffs between ownership concentration and voting power concentration Benefits of concentrated ownership: brings more effective monitoring of management and helps to

overcome agency problems Costs of concentrated ownership: low liquidy and reduced possibilities for risk diversification Benefits of Dispersed ownership: higher liquidity – vital for dev’t of innovative activity Costs of dispersed ownership: does not encourage commitment and long-term relationship Equity markets are important for R&D and innovative activity, entrepreneurship, and the

development of an active SME sector, so corporate governance has an underlying impact on economic growth and development

Corporate governance interacts with the institutional framework in the particular country

Tunc, Andre "Corporate Governance à la Française: The Vienot Report", Perspectives on Company Law : 2, editor Fiona Macmillan Patfield, (1997) Kluwer Law, 121

This article compares French corporate governance regimes to those in the US and UK. The French are largely satisfied with their own regime, despite the fact that it is lacking certain controls present in the US & UK. However, the French equivalent to the SEC, called the Commission des Operations de Bourse (COB), which was concerned that French public companies be governed efficiently and openly (and with a view to satisfying international investors) commissioned a report (the “Vienot Report”) to address the state of corporate governance in France.

History. Present law and practice in France is linked to the pre-WWII situation. In 1940, legislation was enacted that placed responsibility for the company on the chairman of the board (the “president-directeur général” or PDG). He may have assistants, but is always responsible. New legislation in 1966 allowed for an increase of 1 – 5 PDGs for a company, depending on the “importance”($) of the company. The author notes that “the powers of the PDG are limited only to the extent that a bank or some other company holds a significant stake in the capital of the company- which is a fairly common situation.”

Points of Agreement between the French system and the UK/US models. There are four main points of agreement, namely, (i) the responsibilities of the board; (ii) the committees of the board; (iii) informality of the board’s oraganization and functioning; and (iv) a code of best practice. (i) the responsibilities of the board : the board is a collegial organ which should in every circumstance act in the interest of the enterprise. It has four main functions: to define the enterprise’s strategy; to select the agents who will manage the business of the enterprise within the frame of that strategy; to oversee the management; and to take care of the quality of the information given to the shareholders and to the markets through the accounts an don the occasion of very important operations.(ii) the committees of the board : the board should equip itself with a nominating committee, a remuneration committee and an audit committee. At annual meetings it should report on the existence of


those committees and the # of mtgs they’ve had during the year. (no mention of reporting content). Vienot report is more specific wrt the audit committee (e.g. should be able to meet w/o directors, should have at least 3 non-executive directors, one of whom should be independent… etc) (iii) informality of the board’s oraganization and functioning : although the informality of the board may be seen by some as a negative, implicating the quality of the board’s functioning, the Vienot Report considers it satisfactory. There is a general desire for improvement, despite the failure to embrace more rigorous practices. (iv) a code of best practice : restated the duties of the directors (“Charte de l’administrateur”). See list p. 56 v II. List is not exhaustive. Note that idea of fiduciary duties not generally big in France.

Points of “Resistance” to change in the direction of the UK/US models. (i) lack of mechanisms for enforcement of the board’s powers : there are no informational rights comparable to those possessed by the UK/US counterparts.(ii) powers of the chairman of the board : the powers of the chairman are stated very broadly. This is considered positive, i.e. the flexibility is good for the company. Vienot Report against strong separation of powers between board and chcairman. French legislation allows for the possibility of dual boards (directory and supervisory) but the report notes that this is rarely used. (iii) executive and board remuneration : PDG remuneration is unknown, even within the higher echelons of management. It is considered “bad form” to try and find out. While the Report notes that most companies have remuneration boards, there is much cross-appointment and this is a very non-transparent process. (iv) implementation of recommendations : there is no mechanism for implementation, only a request that directors be more aware of their duties.

Conclusion. despite this report, the COB is hoping to modernize corporate governance in France.

Jensen, Michael J. "The Modern Industrial Revolution, Exit and the Failure of Internal Control Systems", Studies in International Corporate Finance and Governance Systems – A Comparison of the US., Japan, and Europe, edited by Donald H. Crew, (1997) New York, Oxford University Press, 18

Fundamental technological, political, regulatory, and economic forces are radically changing the worldwide competitive environment.

Such a metamorphosis has not occurred since the Industrial Revolution of the 19 th century. There are striking parallels between the two movements, most notably, rapid technological and organizational change leading to declining production costs and increasing average productivity of labour.

Technological and other developments have culminated in the mid-20 th century in rapidly improving productivity, creation of overcapacity, and as a result, the requirement for exit.

Question of efficient exit is now at forefront and adjustments necessary to cope with such changes will receive renewed attention.

With shutdown of capital markets in 1990s, challenge of accomplishing efficient exit has been transferred to corporate internal control systems. With few exceptions, US managements and boards have failed to bring about timely exit and downsizing without external pressure.

Major restructuring of the American business community that began in the 1970s and continued in the 1990s is being driven by changes in physical and management technology, global competition, new regulation and taxes, etc. These changes are now bringing a third industrial revolution.

Macroeconomic data from 1980s show major productivity gains. Despite gains in productivity, efficiency, and welfare, the 1980s are generally portrayed by politicians and media as a decade of greed and excess. Contrary to common belief, only 364 offers at the time were contested and only 172 resulted in successful hostile takeovers.


Careful academic research suggests that takeovers have produced large gains for shareholders and the economy as a whole.

Important sources of the expected gains from takeovers and leveraged restructuring include synergies from combining the assets of two or more organizations in the same or related industries and the replacement of inefficient managers or governance systems.

Of course mistakes were made in the takeover activity of the 1980, but these activities were providing, in effect, a healthy early warning system that motivated healthy adjustments to excess capacity building in many sectors.

Excess capacity can arise in 4 ways:1. Demand-reduction scenario: when market demand falls below the level required to yield returns

that will support the currently installed production capacity.2. Capacity-expanding: technological change; increases output of a given capital stock and

organization.3. Obsolescence-creating change: change that makes obsolete the current capital stock and

organization.4. When many competitors rush to implement new, highly productive technologies without

considering whether the aggregate effects will be greater capacity than can be supported by demand.

Since the oil price increases of the 1970s, we have again seen systematic overcapacity problems in many industries. The common underlying causes for overcapacity are:1. Macro policies: major deregulation of US economy under Carter contributed to requirement for

exist in industries like trucking, rail, airline, telecommunications, banking, etc. as did important changes in tax law.

2. Technology: technological developments have had far reaching impact. Computer technology has redefined the capabilities of countless other industries.

3. Organizational innovation: overcapacity can also be cause by changes in organizational practices and management technologies. Vast improvements in communications (email, etc.) change the ways people interact and it is far less valuable for people to be in the same location, so smaller, more efficient units have evolved.

4. Globalization of trade: Asian markets have required readjustments in Western economies and competition promises only to intensify. With globalization of markets, excess capacity tens to occur worldwide.

5. Revolution in political economy: rapid pace of development of capitalism, opening of closed economies, dismantling of communist regimes, bring more low-cost labourers onto the world market. We should not underestimate the stains this continuing change will place on the worldwide social and political systems.

Exit problems appear to be more severe in companies that for long periods enjoyed rapid growth and high cash flow. Culture of the organization and mindset of mangers in these situations seem to make it difficult for adjustment to take place until long after problems have become severe.

In industries with excess capacity, managers fail to recognise that they themselves must downsize; instead they leave the exit to others while they continue to invest. If all managers act this way, exit is delayed at substantial cost.

Information problems hinder exit because high-cost capacity must be eliminated if resources are to be used efficiently. Firms often do not have good info about their own costs.

Explicit and implicit contracts in the organization can become major obstacles to efficient exit. Unionization, restrictive work rules, and lucrative employee benefits can manifest themselves in growing organizations. Faced with technological innovation and worldwide competition – often from non-unionized organizations – these dominant firms have not adjusted quickly enough to maintain dominance.

All organizations must maintain the flexibility to modify contracts that are no longer optimal.


Four basic control forces bearing on corporation that act to bring about a convergence of manages’ decisions with those that are optimal from society’s standpoint: capital markets; legal, political, and regulatory system; the product and factor markets; and internal control system headed by board.

Until shut down in 1989, capital markets were providing one mechanism for accomplishing change before losses in the product markets generated a crisis.

Few have recognized that many of these transactions were necessary to accomplish exit. With the shutdown of these mechanism for motivating change, exit, and renewal, we are left to

depend on internal control system. We must understand why it has failed and learn how to make it work.

Example: IBM is a testimony to failure of internal control – company failed to adjust to the substation away from its mainframe business following the revolution in the workstation and PC market. It changed its strategy and removed the CEO only have huge losses.

These control systems are clearly inadequate. Problems with corporate internal control systems start with the board of directors. The board is the

apex of the internal control system and sets the rules of the game for the CEO. Its job is to hire, fire, and compensate the CEO, but few boards have done this job well in the absence of external crises.

The reasons for the failure of the board are not completely understood. Available evidence suggests that CEOs are removed too late. Other reasons:1. Board culture: emphasis on politeness and courtesy at the expense of truth is both a symptom and

failure in the control system. Few CEOs will accept monitoring and criticism and they ultimately have to power to control the board.

2. Information problems: serious info problems limit the effectiveness of board members.3. Legal liability: incentives facing modern boards are not consistent with shareholder interests and

boards are motivated to serve them through substantial legal liabilities. These liabilities are more often consistent with minimizing rather than maximizing value.

4. Lack of management and board member equity holdings: neither board members nor managers typically own substantial fractions of firm equity. Encouraging them to hold substantial equity interests would provide better incentives.

5. Oversized boards: keeping them small can improve performance. 6. Attempts to model the process on political democracy: this is likely to make the internal control

system even less accountable to shareholders than it is now; we need look no further than the inefficiency of representative political democracies.

A major set of problems with internal control systems are associated with the curbing of active investors, who are individuals or institutions that hold large debt and/or equity positions in a company and actively participate in its strategic direction.

They are important to a well-functioning governance system because they have a financial interest and independence to view management and policies in an unbiased way.

Wise CEOs can recruit large block investors to serve on the board, even selling new equity or debt to encourage them their commitment to the firm.

Evidence from LBOs [AH: I don’t exactly know what these are but it has to do with private equity firms], leveraged restructurings, takeovers, and venture capital firms has demonstrated that leverage, payout policy, and ownership structure affect organizational efficiency, cash flow, and hence value.

LBO associations and venture capital funds provide a blueprint for managers and boards who wish to revamp their top-level control systems to make them more efficient.

They also solve many information problems facing typical boards. As a result of due diligence, both managers and LBO and venture partners have extensive and detailed knowledge of the business. These boards have frequent contact with management and this contact and information is facilitated by fact that LBOs and venture funds have their own staffs. Finally, close relationship between LBO partners and venture fund partners encourages the board to contribute its expertise in times of crisis.


Events of the last two decades indicate that corporate internal control systems have failed to deal effectively with these changes, especially excess capacity and requirement for exit. Making corporate internal control systems work is the major challenge facing us in the 1990s.

Miller, Merton H. "Is American Corporate Governance Fatally Flawed?", Studies in International Corporate Finance and Governance Systems – A Comparison of the US., Japan, and Europe, edited by Donald H. Crew, (1997) New York, Oxford University Press,Miller “Is American Corporate Governance Fatally Flawed” Studies in International Corporate Finance and Governance Systems p.79-86American managers are more concerned with current movements in their own stock prices than are Japanese managers; this is a strength of US corporate governance systemI disagree with Japan’s approach which places less emphasis on stock prices and shareholder returnsMaximizing Shareholder Value as the Primary Objective of the Business Corporation Managerial concern with shareholder value is merely one application of the more general proposition

that in America the individual is king Shareholders drive the shareholder-value principleCurrent Market Values and Future Earnings Focusing on current stock prices is not short-termism. Focussing on current earnings might by

myopic, but not so for stock prices, which reflect not only today’s earnings, but the earnings the market expects in future years

Market-value-to-book-value ratio: book value approximates what management actually spent for the assets the market is valuing, so ratio of 1.0 means firm has no competitive advantage or disadvantage

Ratio above 1.0 means firm must have long-term competitive advantage allowing it to earn a higher than normal rate of return on its productive assets. This is hard to maintain – attracts competitors, driving profits and share prices down

Investors buying into a firm are thus making judgments not only about whether the firm and its managers have produced a competitive advantage over their rivals, but also about how far into the future that competitive advantage can be maintained

Japanese banks, unlike in the US, can hold equity positions in the companies to which they are also lending

Some have argued this is good for monitoring But any gains have come at substantial cost on other fronts: when stock market collapses, the

disappearance of the banks’ equity reserves can threaten the solvency of the banks and the integrity of the country’s payment system.

In Japan, the companies also hold stocks in the banks – unstable, positive-feedback asset pyramid.Stock Prices and Information In Japan, the Ministry of Finance (MOF) intervenes a lot in the market, meaning the market: anti-

selling rules and taboos MOF means that prices are systematically distorted, tilting the scales against selling No form of corporate governance can guarantee 20-20 vision by managemtn My claim is only that those American managers who do focus on maximizing the market value of the

firm have a better set of correcting lenses for properly judging the trade-off between current investment and future benefits than those who focus on maximizing growth, market share, or some other presumed strategic advantage

Management Objectives and Stockholder Interests Glasses help you see better only if you wear them: some argue that managers are left free to pursue

objectives that need not conform to those of the stockholders (because ownership of US corporations is so widely dispursed)

But shareholders are not powerless: elect Board of Directors (design program for executive compensation)


Compensation Packages and Management Incentives Giving managers stock lets them participate in the gains from their successful moves, but still does

not solve the problem of excessive managerial timidity (excessive relative to the interests of stockholders, who are presumably well-diversified)

So well-designed stock options magnify the upside potential for the manager relative to the down Distinction between social costs and private costs: if a corporation has market power, can sell at

above marginal cost; if other companies enter the market, increased competition and price goes down. This might entail a private cost to stockholders, but there’s no social cost

But by diversifying, the shareholder can avoid any meaningful private lossConclusion Two different views of what is wrong with American corporate management: (1) Japanese view: that

US managers pay too much attention to current shareholder returns; (2) US managers pay too little attention to current shareholder returns

Both can point to specific examples seemingly to support their position, but both are wrong in claiming any permanent or systematic bias for US firms in the aggregate toward myopia or hyperopia (underinvestment or overinvestment relative either to the shareholders’ or to society’s best interests)

There is no inherent bias because market forces remove control over corporate assets from managers who lack to competence or the vision to deploy them efficient.

The ultimate discipline for the managers of one firm will always be the manager s of other competing firms. As long as competition is there, I can’t become terribly concerned about the supposedly fatal flaws in our governance system

Kester, W. Carl "Governance, Contracting, and Investment Horizons: A Look at Japan and Germany", Studies in International Corporate Finance and Governance Systems – A Comparison of the US., Japan, and Europe, edited by Donald H. Crew, (1997) New York, Oxford University Press, 227

Networks of contractual relationships generally. All businesses exist within the context of contractual relations with others that purchase or supply goods, services, and capital. How these relationships are structured can influence the amount, type, and timing of a company’s investment decisions. Generally, when companies can build and maintain strong, enduring commercial relationships they will be more favourably disposed to investment in specialized assets. Both GER and JPN have manufacturing sectors that are highly competitive with that of the US, however, they have different approaches to contractual relationships. Investment is at least partly a contracting problem. The absence of assurances from critical suppliers that goods necessary for production will be available at acceptable prices can result in deferred, reduced, or even no investment. This has been recognized both in agency-theory (e.g. Berle and Means) and transaction-cost (e.g. Coase) economic literature. Absorbing key suppliers, customers, or subcontractors (that is, integrating vertically) may afford greater control and relieve some of the hazards of self-interested opportunism, but often at the expense of efficiency.National Differences in Contractual Governance. Typically US manufacturing co’s have addressed the contracting issues above through relatively high levels of integration with suppliers; relying heavily on formal K enforced by courts; and relying on arm’s-length, bid-princed transactions with a large # of competitive suppliers, customers, sub-Krs etc. By contrast, GER and JPN rely more extensively on implicit, relational K and on different dispute resolution processes to enforce adherence to formal K.

Japanese Contractual Governance. From Western perspective, practices often seem like subtle mechanisms for restricting trade and competition. However, authors suggest they are actually well-thought out and not tied to culture. Autonomy v control – Japanese co often engage in tight, l-t vertical relationships, made manifest in keiretsu (defn: complex groups of companies federated around a major bank, trading company, or large


industrial firm.) Keiretsu tend to be characterized by a great deal of stability in group affiliation and loyalty as far as the preferred status group members give each other. Intra-group trading is reciprocal to the greatest extent possible. However, intra-group commercial relationships are never exclusive. The power of competition is respected as a method of generating low costs, high quality, and attention to customer’s demands. Implicit, relational contracting – typically consists of “basic agreement” and “claims compensation agreement”. Signing of basic agreement is tantamount to starting a LTR. Although this is not a detailed document, the reference point for all future discussions regarding the transaction in question will be the entire business relationship, rather than merely a formal K. Quote from JPN exec: “In America, you have many rules [to govern business transactions]. Here is JPN, everything is very fluid. There may be rules, but they are constantly chancing to suit the environment…. The overall benefits of an ongoing relationship is what really matters.” Managerial interactions and lifetime employment – the ongoing nature of relationships in this system requires a high level of communication. This is facilitated by the practice of transfers of management between related companies. This leads to an extensive, enduring web of personal relationships. A Japanese manager’s effectiveness, and thus his value, depends quite heavily on his reputation for trustworthiness and his ability to contract implicitly with counterparts in other companies.Monitoring and Information sharing – the main banks that finance the companies often have ownership stakes in them as well. There are also commonly associations of group member companies, which diminishes the amount of hidden information and reduces the scope for undertaking hidden action. E.g. Mitsubishi group has monthly meeting to “promote friendship”. This and other similar groups are important safeguards in governing relationships.Reciprocal Equity Ownership – over 70% of publicly listed JPN cos are owned by financial institutions and other corporations. There is a generally understood and rigorously observed agreement not to sell shares held in connection with ongoing business relationships. Cross shareholdings among Japanese companies results in a complex blend of complex claims held by 2 companies against each other. This makes it more likely that companies will work together to hammer out temporary financial problems.Selective Intervention – possibly the most powerful safeguard in Japanese contractual governance systems. Equity-owning stakeholders can intervene directly and explicitly when necessary to correct a problem.

German contractual governance. German companies are more vertically integrated than JPN but less so than US. But like JPN, have much greater involvement of banks; however, more formal K relations than in JPN.German corporate ownership structure – available evidence suggests that large GER co engage in fairly extensive cross-shareholdings. Financial institutions are especially large holders of equity in GER corp: by end of 1988, approx 40% of all market value of outstanding domestic GER shares were deposited in GER banks. Through “vollmachtstimmrecht” the banks can vote shares held in deposit on behalf of the depositor. For many years this right of proxy was virtually automatic, indefinite in duration, and did not require instructions from the true shareholder. Board Composition – the influence of large GER shareholders is exercised largely through the Aufsichtsrat (supervisory board), which is one of the more important safeguards embodied in the GER system of corp governance. Briefly, GER commercial law provide for 2 forms of limited liability stock companies: the Gesellschaft mit Haftung (GmbH); and the Aktiengesellschaft (AG). The former is privately owned and unlisted, and the latter publicly owned and listed on a GER stock exchange.

By law, the AGs have 2-tiered boards. The Vorstand, or management board, has day-to-day executive authority over the company and is the real decision-making body on most matters. Typically, it has between 5-15 members … it must report to the Aufsichtsrat and gain its consent for major financial and investment decisions…. The Aufsichtsrat (in contrast) is a true supervisory board, not an executive one. Half of its members must be elected worker representatives. … Typically they are not strictly disinterested/objective; nor are they “status lenders” as is common in the US/UK.


Small numbers and reputation effects – the relatively small circle of companies and executives that dominate business in GER lead to the magnification of the importance of reputation. There is a potential for sharing information, which should contribute to limiting abuses of trust relationships, which should in turn promote efficient implicit contracting.

Comparison and Summary. By and large, both JPN and GER have evolved highly effective systems of contractual governance as far as the promotion of LTR are concerned. (If need more detail, see p. 98.) Hostile takeover are almost unheard of in both those countries. Neither has had an active market for corporate control because they have not needed it, not because they couldn’t tolerate it. Their traditional corporate and contractual governance systems have dealt with the hazards associated with information asymmetries, investment in specialized assets, and agency problems. This efficiency has reduced the need to integrate vertically in order to secure upstream sources of supply or downstream markets.

Reflections on Anglo-American Contractual Governance. Vertical anti-trust versus efficiency in exchange – in the late 19th C/early 20th C, large American banks owned equity in, and provided loans to, and underwrote the bonds of, their major industrial clients. The fortunes of these financial institutions became intimately linked to those of their major customers, resulting in close monitoring of their activities.

The US anti-trust legislation that was originally aimed at preventing horizontal mergers, has taken over … where GER and JPN saw efficiency, US saw abuse and prevented it. The banking and securities legislation (e.g. Glass-Steagall Act of 1933) and tax laws pertaining to mutual funds constrained the degree to which banks and other large “inside” investors could involve themselves in corporate supervision. Reforming Anglo-American Contractual Governance – it may not be possible, or good, just to transplant the systems of one country into another place. But that doesn’t mean that the methods of contractual governance practiced in GER and JPN are culture-bound. US could benefit from their better attributes. Japanese-affiliated auto-makers in the US have successfully entered into supply contracts in the US patterned after their relationships with suppliers at home. The 1980s have seen emerge a kind of Darwinistic ‘competition’ among systems of contractual governance for global dominance. Judging from the remarkable contemporary successes of GER and JPN companies, and recent innovations that embody components of governance commonly found in GER and JPN, it is by no means clear that the classic Anglo-American governance standards will be the winner of this competition.

Barr, Graham, Gerson, Jos and Kantorm, Brian "Shareholders as Agents and Principals : The Case for South Africa’s Corporate Governance System" Studies in International Corporate Finance and Governance Systems – A Comparison of the US., Japan, and Europe, edited by Donald H. Crew, (1997) New York, Oxford University Press, 297

[AH: I couldn’t find any mention of this article in my class notes, in fact, there was only one mention of South Africa, so I will just briefly summarize the main points of this article.]

Johannesburg Stock Exchange (JSE) is dominated by a small set of very large companies who principal assets are shares in other listed subsidiary and associate companies.

Ownership in the principal companies is widely diffused, although South African institutional investors are well-represented among shareholders. Management control of the groups is highly concentrated, usually in the hands of the founding families.

This type of control has been accomplished through use of tiers of holding companies called “pyramid companies,” whose major or only asset consists of a controlling shareholding in another company.

The ownership structure that dominates in South Africa is different from the proportional or one-share, one-vote arrangements that prevail in the US and UK.


The standard assumption in the US and UK corporate governance is that ownership entitles the shareholder to proportional representation. While this may be appropriate for US, UK, and Australia, the rule of one-share, one vote does not apply to national economies where small groups of shareholders often exercise effective control.

In South Africa, laws prohibit the issuance of non-voting shares. But where the law forbids this, the same end can be achieved through holding companies (whose assets include shares in another company) and pyramid companies (whose only asset is shares in another company for the purpose of exercising control).

More recently in the US, attitude toward limited voting shares appears to have shifted toward greater tolerance. After much debate the SEC finally proposed a rule that allows the issuance of new low-voting or non-voting stock that prohibits exchange offers to replace outstanding shares with limited voting shares (because such offers are felt to be potentially coercive).

In sum, a 50% voting rule for control purposes is not a barrier to maintaining absolute control. Control may also be maintained by a minority of shareholders and separated from ownership.

In South Africa, there have been important preliminary moves toward deconglomeration. The essence of this process of concentrating control while diffusing ownership claims is that the founders are able to attract outside share capital, without conceding control.

In effect, the near silent majority of shareholders trade off their power to control the structure for the benefits of the controls and entrepreneurship that they believe will be exercises on behalf of all shareholders by the controllers.

Where the controllers of a corp have succeeded in retaining a majority of the votes despite having less than a simple majority of the ownership claims, there is no possibility of separate control by managers.

Within a South African group, the removal of an unsatisfactory officer and team is a simple task, no takeover battles required. The hostile takeover is also rendered impossible.

But one set of principal-agent problems is substituted for another. While controlling shareholders have absolute power to appoint and dismiss managers, there is no guarantee that they will not abuse this power to promote their own interests at the expense of the non-controlling shareholders.

It is useful to question the effectiveness of exchange control in South Africa. It is an empirical issues whether exchange control actually succeeds in its purpose of increasing the available supply of capital over time.

All South African corps will have more freedom to diversify internationally in the absence of exchange control. The opportunity to diversify internationally is likely to encourage a more focused, less conglomerate structure for large South African corps.

Conclusion: A central problem of modern capitalism is the potential loss of control over managers. Concentrating control with an influential minority of shareholders may be an answer to this problem. But these arrangements still produce their own kind of principal-agent problems.

The group system in South Africa that allows control to be concentrated and wealth to be diversified is in large measure an outcome of competition for capital and managers. The process of group creation should be tolerated rather than regulated by hostile regulation. Conglomerates and groups may work for some wealth owners and there should be no predisposition in favour or against them.

The best governed corporations are those that survive the market test. The best policy is to ensure that barriers to competition are kept at a low level.

Pastre, Oliver "Corporate Governance: The End of ‘L’exception française’?",(1998) Columbia Business Law Review 79Pastre “Corporate Governance: the end of ‘l’exception francaise’?” Columbia Business Law Review p.117-124French Peculiarities


The Board represents not only shareholders, but also employees, clients, suppliers, etc, i.e. in France corporate governance has a much broader meaning that in the US; also, employees, clients and suppliers are integral parties in management. Lastly, there is very little legal framework regarding corporate governance

In France, there is a greater weight of small and medium companies (SMC). The confrontation between shareholders and managers does not have the same significance

The manner in which the industrial elite are recruited in France is unique: usually appointed after a career not with the company, not even in the business world

Financial intermediaries provide the link between those who have surplus saving and those who need finance; not individuals finance themselves through financial markets

The State plays a bigger role: for a long time, State could intervene in sectorial recomposition. This is a bit changed by liberalization and globalization

These lead to the following four characteristics: (1) limited room to the financial markets; (2) less subject to outside control; (3) shareholding is concentrated; (4)even when it exists, internal or external control is not much exercised

Towards a New Lease of Life for Capitalism “à la française”? The State, one of the pillars of the system, has subsided under the converging battering rams of

liberalization and globalization Having come about rapidly, in many cases this retreat has taken place in a disorderly fashion Three other phenomena: (1) there is more and more criticism of internal control; (2) small

shareholders are more aware, and make themselves heard; (3) “affairs” are happening more and more, i.e. insider dealing, political party funding etc. leaving company chiefs in prison…

Capitalism is always evolving So how has French capitalism changed? Two trends in two different direction: moved closer to the

Anglo-Saxon model, but yet, though changing, it has anchored itself to its specificity and getting more distant from Anglo-Saxon model

Moving closer by: (1) dev’t of role played by minority shareholders; (2) movement to provide more information – quest for transparency

Forces of Friction There is much rigidity remaining: (1) the protectionist impulse, defend the integrity of national

industry; (2) pension funds issue – nothing that resembles Anglo-Saxon pension funds is appearing on the horizon; (3) boards of directors – plurality of mandates remains the rule (as opposed to independent directors); (4) Most SMCs pay no dividends today – the defense of short term shareholder interests is not at the heart of the question of corporate governance in France

There has been some worldwide “movement to the middle,” with US making certain alterations making it more like continental Europe too

Despite the tendency towards uniformity, the specificities remain Two highly prominent debates in US do not appear at all to be priorities in France: management

reward schemes and takeovers. We should wake up to the fact that France is not yet truly a capitalist country

March 15, Class 18: Is there an emerging transnational corporate governance regime?These readings canvass efforts to unify corporate governance regimes. Is this a worthwhile project? Is it anomalous that transnational firms cannot yet be said to operate within a transational corporate governance regime?

Farrar, John H. "The New Financial Architecture and Effective Corporate Governance", 33 (1999) International Lawyer 927

principle driving forces in globalization are capital market imbalances; innovations in computer and


telecommunication technology, deregulation and the influence of modern finance theory on risk and diversification, hedging, and arbitrage. Idea of globalization is not new.

the Southeast Asian financial crisis contributed to the perception that there is a great need for increased transparency, accountability, and prudential supervision to regulate the financial services industry

the term corporate governance is remarkably imprecise. There are a number of related ideas that go under this heading, but each country has approached it from the perspective of their own distinctive culture. For this article, adopt the definition that corporate governance is about “the legitimacy of corporate power, corporate accountability, and the standards by which the corporation is to be governed and by whom, it is obvious that the concept transcends legal standards and liability, perhaps reflecting the fact that the law deals with a minimal morality of obligation rather than a morality of aspiration.

Eugen Ehrlich: “The centre of gravity of legal development … from time immemorial has not lain in the activity of the state but in society itself, and must be sought there at the present time.”

speed and complexity of change has threatened the capacity of national governments to deal with the local impact of change, particularly when it results from events on the other side of the world. In the past, national governments have encountered globalization mainly through the activities of multinational and trans-national enterprises. Trans-national enterprise has eluded the regulation of nation-states, and even regions, in the period since WWII.

the fact that a multi-national enterprise is not one discrete legal form but many makes it even more difficult for states to deal with. Wolfgang Friedman wrote: “It is the complexity of its legal structure, or rather the interplay of legal entities and relationships constituting that structure, no less than the size of its resources or operations, which makes its power so elusive and so formidable a challenge to the political order and rule of law. It is therefore inherent in the nature of the multinational corporation that there is no simple solution for the problem of its relationship to states, the world of states, or an organized world community…”

political and legal regulation of multinational enterprises (MNEs) may be classified under 4 headings that correspond roughly to stages of historical development: (i) national; (ii) bilateral; (iii) regional; (iv) international regulation.

(i) national : there are problems with national regulation when the MNE keeps most of its assets outside the state seeking to regulate it – the latter will be unable to access those assets to satisfy judgements. There is a conflict between regulating conduct against national interest and not discouraging foreign investment. Apart from loss of control, the individual nations worry that MNEs will reduce the effectiveness of the national monetary policy, evade taxation, and injure labour relations. The most effective form of regulation seems to be control over initial capital investment.

(ii) bilateral regulation : this generally takes the form of investment protection and promotion treaties. From the 1960s onwards, treaties have tended to be most concerned with foreign direct investment and are often concluded with developing countries. Today there are over 200 of these bilateral treaties in force, however, they are marginal wrt decision-making of the multinational and the host country.

(iii) regional regulation : e.g. US, CAN, Australia. This section is really short and light on content. (iv) international regulation : the IMF, GATT, and OECD all have some bearing ont eh activities of

MNEs. The IMF provides for convertibility of currency and repatriation of funds. GATT facilitates international production and transfers. OECD facilitates freedom of establishment.

in 1976 the OECD adopted voluntary guidelines for conduct by MNEs. These were not legally binding, but contained statements of general policies. Dealt with topics of disclosure, competition, financing, taxation, employment and labour relations, and service and technology.

Also in the 1970s, the UN set up a Centre on Transnational Corporations (CTC) to gather and disseminate information on multinationals and an intergovernmental Commission on Trans-national Corporations to act as a forum for discussion of related issues and to supervise the centre. The highest priority of the Commission was to create a code of conduct, which they worked on from 1977 – 1992, when the finally announced that no consensus was possible. At that point the CTC was absorbed into


UNCTAD. (doesn’t say what UNCTAD is.) It is easy to dismiss such voluntary codes as unimportant since they are not legally binding, but this

would be a mistake. Such codes may form the basis of subtle diplomacy by the UN towards a consensus among governments, which in turn will be embodies in national legislation or professional standards. Such a consensus will, in any event, help host countries negotiate with MNEs. It may also assist trade unions in both home countries in opposing outward investment and host countries in seeking regulation of MNE practices contrary to the interest of their members.

In the EU, three basic legal integration techniques are: (1) removal of all restrictions that discriminate on the basis of nationality including restrictions on freedom of establishment; (2) the establishment of common rules and common policies; and (3) the approximation of national laws under article 3(h) of the Rome Statute.

with respect to the future harmonization of the EU, it has been noted that the area of least success has been corporate governance, due mainly to fundamental differences in national models and the context in which they operate.

Characteristics of the Global Corporate Landscape: a working paper by 3 Harvard profs (economists) notes the following characteristics: (1) the separation of ownership and control in listed public corporations is far from universal; (2) many of the larges firms are controlled by families; (3) the widely held corporation is most common in countries with good regimes of shareholder protection; (4) family control is more common in countries with poor shareholder protection; (5) state control is common, particularly in countries with poor shareholder protection; (6) in family-controlled firms there is little separation between ownership and control; (7) pyramids and deviations from one share-one vote are most common in countries with poor shareholder protection; (8) corporations with controlling shareholders rarely have other large shareholders.

much corporate governance theory has been based on the Berle-Means separation of ownership and control hypothesis: above survey results indicate that we need to be more diverse and flexible in formulating corporate models at the international level.

it has been argued that sustained prosperity depends on the following basic rules: effective standards of corporate governance; a high degree of corporate transparency and adequate external auditing; efficient stock exchanges; competitive markets; efficient and transparent legal frameworks; a clear distinction between regulators and regulated; independent, transparent, and competitive banking systems; and a well-resourced, inquisitive, and independent media. Many of these characteristics were missing in pre-collapse SEA companies.

since WWII there has been a huge increase in the percentage of institutional investors (e.g. in UK from 17.9 to 60.4 % between 1957 and 1992). In the past decade institutional investors have become more organized and have promoted law reform and the development of self regulation of corporate governance. A recent UK survey shows that “best practice” in corporate governance is generally followed by institutional investors; however, there is much less institutional investment in non-ENG-speaking countries.

in some ways, corporate governance on the international scale is intrinsically political and necessarily vague.

In 1996 the OECD commissioned a study of international corporate governance issues and suggest an agenda and priorities for further OECD initiatives. The report was followed recently by the formulations of draft principles. The principles fall under five broad headings (1) the right of shareholders; (2) the equitable treatment of shareholders; (3) the role of shareholders; (4) disclosure and transparency; (5) the role of the board. Minimal shareholder protection is envisaged to protect participation and exit rights. Fair treatment of shareholders is required. In particular, self-dealing and insider trading are to be prohibited. The principles went before a meeting of OECD ministers in 1999 and were adopted. The World Bank and the OECD will sponsor the Global Corporate Governance Forum, which will meet once a year. Recent announcements clearly envisage the OECD and World Bank playing a lead role in developing norms of international corporate governance. Such an initiative is to be welcomed, but the matter needs to be promoted by other international bodies such as


IMP and WTO because of their broader base. In conclusion, the primary goals of global corporate governance are to promote: (1) transparency in

commercial dealings and financial transactions, especially fund-raising; (2) accountability through more efficient monitoring of management performance; and (3) competition.

We live in a period of complex transition characterized by rapid change and it is difficult to monitor the effects of this change on the existing world order. There are two distinct schools of thought about an appropriate approach to dealing with this. One is a regulatory approach – a projection of national regulation into the international arena. The other is a free-market approach – to leave the development to market forces. The evolution of norms of self-regulation of international corporate governance from initiatives such as the OECD’s Principles represents a possible middle way – a non-legal soft law that can form the basis of the lex mercatoria of this area.

Lecture, Berger "Steps toward a Uniform Corporate law in the European Union", 31 (1998) Cornell International Law Journal, 377

Outsiders might think that the European Union has grown into a homogeneous unit, but it remains a loose functioning of states.

Central element of the EU is the European Economic Community (EEC), which was established with the goal of setting up a common market for all its members.

The goal of achieving a fully operational unified legal framework still has not been completely realized.

The bases for achieving an internal market are basic freedoms: free movement of goods, free movement of persons, and free movement of payments and capital. The most important freedoms for corporations are the free movement of persons, the freedom of establishment, and the freedom to provide services.

Freedom of establishment: guarantees the general right to create permanent institutions necessary for the independent operation of business activities and the right to set up corporations. Because various members states within the EU have taken different positions on the recognition of international norms relating to corporate law, corps in the EU face potentially conflicting conditions with respect to their freedom, depending on the state in which the corp was established and the state to which it intends to relocate.

Competitive equality for persons operating in the common market: one can ask whether it is really necessary for the creation of an internal market to harmonize national corporate laws and create supranational corporate structures. Competition over time may ascertain which system proves to be the most sensible and practical.

There are fifty different legal systems in the US and difficulties seldom arise when working between different corporate laws. In Europe, legal systems of the member states belong to different families of law: common and civil (Louisiana is the one exception in the US). Until recently there were no Europe-wide regulations governing capital markets. For this reason, the conditions of healthy competition of legal systems did not exist in Europe in the area of corporate law and still don’t today.

One of the substantial weaknesses of competition between corporate systems is that it may attract a member state to follow a policy of systematic corporate law deregulation with the goal of attracting as many businesses as possible to that country (called the “Delaware effect”). Systematic deregulation risks a decrease in quality of corporate law. Unrestricted competition between the various systems of corporate law is not the right answer for Europe for these reasons.

Forms of harmonization of corporate law: harmonization has always been the goal of the European Commission, which has endeavoured to create a legal framework for corporations operating in a single market that facilitates cooperation and business activity.


The vast majority of Community legislative measures in the area of corporate law are directives, legal acts directed at members states binding them to implement the contents into national law. Directives are at the core of the legal framework for a Europe-wide harmonization of corporate law.

European and national law: national corporate law in many areas has changed thanks to the harmonization measures that have altered the corporate law of member states.1. European Economic Interest Groupings: this is the only Europe-wide uniform corporate form

that currently exists; it is an instrument of cooperation and serves to support the economic activities of its member. It is gaining popularity in the EU and is especially favoured by self-employed persons for cross-border cooperation.

2. European Stock Corporation: so far, has met with little success; is the oldest project directed at creating a standardized corporate form in Europe for cross-border business operations.

Harmonization of national law: of greater importance to national legal systems are the directives leading to noticeable reforms in several areas of corporate law.1. Public disclosure: large number of directives exist to secure third party protection and create

contractual certainty2. Internal structure of corporations: regulations affecting the internal structure of corps and their

public appearance have an important impact on the fabric of the uniform market. 3. Protection of investors: if corps are placed in a position to access equally the capital markets in

Europe, then acquisition modalities laid down in the stock exchange law and the regulations protecting future shareholders must offer the same qualities throughout the EU.

4. Partnership law: law of partnerships has largely been excluded from European harmonization Interim balance sheet: overview of corporate law in all EU members reveals that the activities of the

EC and the spontaneous harmonization of laws between individual members have already resulted in an impressive degree of legal harmonization.

Harmony in the corporate law of the EU states: several areas of correlation exist among national corporate laws of the EU, including: rules governing nominal, or stated capital and its function as a security for creditors; rules for rendering accounts; powers of representation of executive management; possibilities for merging and splitting corps; permitting single person corps.

Differences between national laws: remaining differences concern fundamental issues of corporate law are:1. Administration of stock corporations: dualistic and monist systems exist; draft directive would

attempt to harmonize the articles of national stock corporations by allowing European corps to choose between several different options. Author doubts whether this choice will really bring about an equality of regulations.

2. Codetermination: large differences in approach in Europe; with wide range of options, draft guideline does not offer the prospect of accomplishing harmonization in this field.

3. Corporate law relating to groups: clear differences exist with respect to corporate laws relating to groups; in most states, protection is afforded by relevant regulations governing the capital market. Some protections have been developed by judge-made law. Germany system is unique, based as it is on a group contract, is unique; in most states, concept of prescribing a contractual relationship to regulate the relationship of the corp to the group is considered to be an unnecessary prescription that is foreign to the business possibilities available to a group.

4. International corporate law: the foundation theory is based on the assumption that a corp formed according to the laws of a state will be recognized as a body possessing legal personality for the entire duration of its existence and that it will still be recognized as such even if it moves its registered place of business out of the state in which it was founded. If all states in the EU followed the theory, corps would be free to move without restrictions. However, under place of registration regimes, corps must fulfill the requirements for registration of the state in which the principal place of business is located. Foundation theory is practiced in some states. Harmonization of the rules for regulating the conflict of corporate laws in line with the foundation theory is necessary within the EU.


Conclusion: corporate law in Europe is heading down right path. If a truly uniform internal market is to be achieved, a framework of laws for organization of businesses that has a neutral impact on their competitive situation must be created. Differences that remain are based on different national attitudes. Willingness to compromise is required.

Visentini, Gustavo "Compatibility and Competition Between European and American Corporate Governance: Which Model of Capitalism?", Vol : XXIII (1998) Brooklyn J. Int’l L., 833Visenti “Compatibility and Competition between European and American Corporate Governance: Which Model of Capitalism?” p.163-172.The Debate about Corporate Governance Relationships among various corporate actors, especially wrt publicly held corporations, i.e. public

shareholders (supposedly defenceless), rise of institutional investorsThe Legal Relevance of Corporate Governance It is meaningful to talk about “corporate governance” when you’re not talking about traditional

corporate law issues concerning the management of the corporation, or the relationship between shareholders and directors

Common element in definitions of corporate governance: relationships among participants in a corporation; i.e. a peculiar profile of a whole set of legal tensions and relationships that find their focus point within the company

Definition I’m working with: corporate governance is the process of bringing together the different forces which, based upon rules of law, have a significant impact on those who participate in the corporation and, eventually, determine how power is exercised within the corporation

The Market-Oriented Model (MOM) and the Bank-Oriented Model (BOM) Market-Oriented: well represented in US, corporations collect capital directly from the public, the

public investors directly bear the business risk of the investment; financial markets are very competitive, generally high fragmentation of ownership

Bank-Oriented: well represented by Germany and continental Europe, high degree of intermediation (by banks) in the channelling of savings from households to companies, typically, major shareholders in a corporation (i.e. banks)

Legal Foundation of the Distinction between the Bank-oriented and the Market-oriented Model Difference is in the separation of the banking industry from the securities industry, and the different

range of activities that banks can engage in MOM: firms have a broader choice of financing alternatives and enjoy greater competition among

suppliers of capital, as the banking industry is not the sole provider of credit, but a competitor of the public markets in providing finance for companies

BOM: often a single bank, or bank group, will dominate the financing of the firm, whether through equity or debt. The role of the bank is central to corporate finance. Note: there’s still a stock exchange, but the organization of the stock exchange rests upon banks (i.e. buying and selling, executed on the exchange, but channelled through the banking network)

The Legal Structure of the Financial System and its Effects on Corporate Governance Rules MOM: variety of competing sources of funds causes a more diffuse control of the corporation and

creates a complex system of check and balances among stakeholders See US corporate governance rules: major focus is protection of individual investors through

disclosure and effective enforcement of liability Recently in US: large investors, such as pension funds, that have the resources to acquire large stakes

in companies and therefore take an active role in management BOM: a greater concentration in the ownership structure of corporations configures a system of

corporations where the predominant shareholder pattern is the large and active shareholder. Control is tightly held through complex systems of close relationships (e.g. cross and circular holdings of


shares). A greater variety and amount of corporate power is granted to the individual, with the assumption that the shareholder will have the capacity and incentive to exercise such powers.

The Competition between the Different Models of Financial System MOM: more flexible in adjusting to changes because of greater reliance on market mechanisms, but

costs in terms of crises its industries have to undergo when facing those adjustments BOM: less flexible, but more stable and fine-tuned process of adjustment and adaptability US and European companies compete Globalization of markets for goods, but less true that globalization of markets for finance happeningThe Globalization for Finance: the Direct Competition of Financial Institutions and its Possible Effects on Corporate Governance As globalization progresses, the legal distinction between MOM and BOM becomes less significant:

greater uniformity and harmonization of the regulatory framework Although the globalization of finance is growing stronger wrt investment services, there are still quite

high barriers to the transnational offering of banking services: very costly to set up a new network; public policy concerns connected with banks and their role in monetary policy tend to keep the banking industry protected from outside competition

The globalization of finance, forcing financial institutions coming from different systems to compete directly with each other in providing resources to industrial companies, will bring about new dev’ts: changes in corporate governance structures

The Political Issues Arising form Globalization Globalization: international markets, but politically fragmented, i.e. State’s political responsibility to

its own community comes to struggle against greater economic freedom Protectionist policies: not just expressions of an out-of-date nationalism; the state has political

responsibility to its constituencies. It cannot afford to lose sovereignty over particular industrial or commercial sectors, although those sectors may be more efficient if allocated outside the country

If efficiency drive the only allocative mechanism, such market mechanisms will eventually overrule Parliaments and governments, that will e de facto expropriated of their legislative and executive powers wrt the global economic actors: the host country will have no sovereignty over the foreign institution, wheeas the home country of the institution will have no interest in regulating the operations of the institution in the foreign country.

Conclusion: Which Model of Capitalism? Despite globalization, the market still operates, and will continue to operate, according to

mechanisms founded upon the struggle and dialectics among private, public and administrative powers.

The objective of strengthening and favouring the functioning of market mechanisms is gaining prominence over the objective of keeping the economy under strict control

In this context, the legal framework, while becoming globalized in its protection and enforcement of property rights, becomes the essential pillar upon which the market operates, and, hence, market forces efficiently allocate wealth and resources

No new model of capitalism is probably arising, but, as a consequence of new forces and impulses, societies as a whole will certainly undergo a drastic and revolutionary change, heading towards a new international economic order.

March 17, Class 19: Does contemporary corporate governance reflect injustice in corporate law?These readings present important critiques of treating corporate govenance problems simply from the perspective of serving shareholder interests or improving on firm performance. What, if any, should be the legal implications of these critiques?


O’Neill, Terry "The Patriarchal Meaning of Contract: Feminist Reflections on the Corporate Governance Debate", Perspectives on Company Law: 2, edited by Fiona Macmillan Patfield, (1997) Kluwer Law, 27

there is an emerging progressive communitarian theory that holds that the modern corporation is a large, powerful economic institution in which many people have a vital stake.

in O’Neill’s feminist theory of the corporation, each participant is a fully autonomous objective Self (capital S), who deserves to be continually empowered to define and to express her own interest. In this system, each participant has an ongoing obligation to respond to and cooperate with every other participant, recognising the latter as an equally fully autonomous subjective Self.

in response to the development of ideas of CSR in the 1970s, Jensen and Meckling came up with their “the firm = a nexus of contracts” idea and claimed that because the corporation is a web of contractual relations, it cannot be said to have any social responsibilities. O’Neill points out that there is a conceptual mistake in this theory – J&M confuse the idea of having a social conscience (clearly impossible) with having social responsibilities (which they definitely do, and don’t have to be a person for).

The central problem with the web of K clustered around a core agency contract is that managers might Welch on their deal by “shirking” or “stealing”, thereby reducing the corporation’s bottom line to the detriment of shareholders. Stated in economic terms, the central problem is the problem of agency costs. The goal of the legal system, accordingly, must be to create and maintain structures that will control managers’ natural inclination to shirk and steal. Stated in economic terms, the goal of corporate law is to minimize agency costs. This happens through market forces and fiduciary duties.

the result of all of this is that the official story of the corporation, as told by neoclassical economic theory, is one of discipline and control. Viewed from a feminist perspective, this theory of the corporation can be seen as a particularised expression of patriarchal ideology, a version of patriarchy tailored to fit the context of the modern business corporation. It is laced with metaphors of gender, i.e. those “unproven unprovable” assertions about gender differences that are constructed by patriarchal thought to shore up the practice of male domination.

This gendered world view permeates and sustains the neoclassical economic theory of the modern corporation. The neoclassical theory makes a series of claims about corporate participants which are demonstrably counterfactual, but which perfectly capture patriarchy’s (equally counterfactual) gendered construction of human experience. The neoclassical claims include, for example, the assertion that all economic actors are motivated only by self-interest. Another salient example is the managers need to be disciplined and controlled.

By patriarchal logic, the ‘feminine’ traits are the opposites of ‘masculine’ traits, and are wholly incompatible with them. The neo-classical economic theory of the modern corporation falls neatly into line with these gendered designations. It accepts the patriarchal imperative that only the masculine traits of self- interest and self-interest-seeking can be admitted into a discourse about the masculine world of commerce. Accordingly, even though neoclassical theorists would acknowledge that in fact commercial actors are not solely self-interested, their patriarchal ideology nonetheless compels them to take the position that that which is feminine – empathy, reaching out to serve another’s needs – must be utterly excluded from any theoretical discussion of the world of markets and of commerce, which is the world of men.

Similarly, the neoclassical stance that corporate managers are saliently characterized by their need for discipline and control is driven by a patriarchal ideology’s assignment of gender classifications. Even though managers adopt this role autonomously, acting in their own interest, once they have become servants they are transformed. In the gendered universe of patriarchal thought, servants are feminised, They are the opposites of gendered masters, who are masculine. As feminised beings, servants cannot be autonomous or self-interested, because those are masculine traits. Indeed, one of the essential features of a patriarchal system is its denial of women’s autonomy and its concomitant obsession with


controlling women’s behaviour. the differences claimed between shareholders and other stakeholders are also based on patriarchal

constructions, and are therefore equally wrong. what it all boils down to is that those with the right to be self-interested are masculine; the managers,

by agreeing to serve the needs of others have taken on the mantle of womanhood and must therefore be controlled, disciplined by exogenous forces such as by markets and threats of derivative litigation.

Dallas, Lynne "The Global Corporate Board of Directors: A Proposal for Reform," Perspectives on Company Law: 2, edited by Fiona Macmillan Patfield, (1997) Kluwer Law, 27

Introduction: A number of legal and societal pressures have encouraged US corps to increase the number of outsiders on their boards of directors. Important to this trend has been the increase in the number of independent directors, who are non-employees with no business connections of any kind with the corp.

The pressure for independent directors is largely attributed to the importance attached to the monitoring function of the board.

Eisenberg argued in the mid-1979s that the monitoring function was the only function that the board was suited to perform and argued for various structural reforms that would make the monitoring more effective.

Managerial hegemony theory of the board: Eisenberg’s reforms were grounded in the managerial hegemony theory, where the board was seen as dominated by management and thus, ineffective in performing monitoring.

The solution of contra-managerial hegemony theorists was to decrease managerial domination by adopting internal structural rules that would assure directorial independence.

The contra-managerial hegemony theorists were successful in having a mandatory provision included in the ALI’s Principles of Corporate Governance, requiring large public corps to have a majority of independent directors on their boards.

The agency cost theory of the board: opposition to this mandatory provision was grounded in the agency cost theory of the board. These theorists did not dispute the importance of monitoring or of outside directors. Where they differ is in their opposition to mandatory rules on board structure. Agency costs theories believe that the optimum composition and structure of boards will result from the discipline of market forces, and it is these forces, not law, that should determine board composition and structure.

These theorists have recently proposed the “substitute hypothesis” which suggests that alternative mechanisms exist to minimize agency costs. When mechanisms other than boards used to reduce agency costs, the board’s monitoring role is less important and consequently, the outside directors’ role is of less value.

A problem with the debate between contra-managerial hegemony and agency cost theorists is their tendency to focus on the shareholder-management relation. This focus is grounded on the legal monitoring model of the board, but this focus ignores the board’s broader role in forging relationships with other individuals and corps that have resources important to the corp’s survival. With global competition, understanding the broader relational roles of the board becomes important.

The power coalition theory of the board: this theory is based on resource dependence theory, according to which, the board permits the corp to perform a number of functions, enabling it to relate to a diverse, uncertain environment.

The corp may benefit from board memberships by improved: coordination with its external environment; info access and exchange; advice from experts; support of board members due to their identification with the corp; status of legitimacy of the corp acquired by having such members on the board.


Example: consumers or environmentalists on the board may signal to relevant communities that the corp is responsive to their concerns.

Author disagrees with Eisenberg’s belief that various relational roles can be as effectively performed outside boards. Boards provide a unique and effective means for the corp to relate to resource providers.

Unlike the monitoring theories of the board, the broader relational roles of the board, suggested by power coalition theory, demonstrate the importance of having on the board a mix of inside and outside directors with different backgrounds.

Conflicts monitoring: a board ideal for conflicts monitoring would consist solely of independent directors who are not corporate stakeholders. A mix of directors is needed for more other relational roles, suggesting that contra-managerial hegemony theorists do not go far enough. They do fully appreciate the importance of psychological influences that threaten the independence of directors on a board composed of employee directors and outside directors with business connections with the corp, who may have conflicts of interest.

A variety of power considerations will influence board composition, including the power of corporate executives to influence board composition.

Evidence suggests a substantial amount of conformity pressures on corporate boards, which supports a board composed of independent directors for conflicts monitoring.

The proposal for public corporations: dual board structure would consist of a conflicts board and a business review board. The conflicts board would handle situations that raise the greatest likelihood of conflicts of interests and would consist solely of independent directors. The business review board would preserve the relational aspects of the board and assure management the advice and other resources that it needs to further the corp’s interests. The composition would vary depending on the corp’s needs. The author would also recommend that that conflicts board have an ombudsperson to assist it in fulfilling its functions. It is hopeful that this person would obtain early warnings of illegal and unethical corporate activities.

Some objections: main objection might be that a dual structure is not necessary. Another objection is the potential for overlapping functions of the boards. However, they would not be in competition with each other and each would have its own distinct area of responsibility.

To some degree, the dual board structure has been foreshadowed by the tendency of US corps to form committees composed of independent directors to handle matters raising managerial conflicts of interest and also by the deference of US courts to the findings of these committees.

The global corporation: corps associated with foreign corps may find the dual board of special interest. Representatives of foreign affiliates may provide services on the business review board and advice on global issues. The corp’s interests may be best served by having issues that raise conflicts of interest for foreign representatives decided by an independent conflicts board.

Conclusion: there is room for improving the function of corporate boards. The reform proposals suggested are designed to enable corps to relate more effectively to their environments and avoid the adverse effects of managerial conflicts of interest. Attention to these concerns will assist corps in meeting the competitive demands for a global economy.

Carver, Anne"Corporate Governance – Capitalism’s Fellow Traveller" Perspectives on Company Law: 2, edited by Fiona Macmillan Patfield, (1997) Kluwer Law, 69Introduction


Hayek, the great defender of capitalism, said political freedom is meaningless without economic freedom.

The law sets minimum standards of conduct. Mere compliance does not necessarily make a good citizen or a good company

This piece emphasizes the importance of the corporate governance debate to the law and morality (or lack of them) of late twentieth century capitalist beliefs in freedom of choice and freedom of economic activity

What is Corporate Governance? The word “governance” (controlling, directing or regulating influence), coming from Medieval Latin,

was not allied to the word “corporate until 1984. The concept is by no means universally accepted as a central, essential issue to be addressed when

considering the management of commercial organizations The question of the internal and external responsibilities of the company arises frequesntly in

discussions of business ethics, most significantly in the context of what “social responsibility,” if any, exists for the business organization

Corporate governance is essentially a question of responsibility and its entrenchment Many MNCs, by the mid 1980s, had grown to such a size that they outstripped the size and power of

many governments Unlike governments, companies in theory exist merely for the furtherance of their own interests –

their “electorate” is their shareholders, but shareholders’ have small role There is no one exemplary definition of corporate governance, there are three theories upon which

discussion of corporate governance may be built: Agency theory: the company is a set of contracts between principals (SHs) and agents (mgt).

Assumption that directors are the contractual servants of SHs. Since SHs are liable for actions of directors, they should be able to issue any type of instructions to the directors concerning their performance. Advantage: directors are fully accountable to SHs. Disadvantage: SHs are not trained managers but will be overriding the judgment of people who are. This theory emphasizes the interest of SHs above all else

Management-centred view: Directors are stewards to whom the company has delegated responsibility and authority while requiring appropriate accountability from them. Shift from management by owners to professional managers with little or no capital invested in the company. Management is more concerned with its own well-being that with maximizing SH returns

Social Responsibility: new emerging theory. The corporation provides employment in the locality, work for services in the locality, revenue for local government, and if enlightened, it may also pay a significant role in supporting local arts, sports, welfare and education. If short-term profit is the only factor considered by corporations, society, local or national, may be adversely affected although the corporate balance sheet benefits. Issue: should the corporation accept a duty to behave as a good corporate citizen?

Legal Theories of the Company If we accept that corporate governance debates are about limits on authority and attempts to

legitimate the authority exercised in theory and in practice by the directors and managers, then we must examine how concepts of legitimacy and authority have changed from 19th to 20th centuries

19th century model: directors were agents of the company whose authority could be revoked at any moment by the shareholders who, as principals, could issue specific instructions to the directors, their agents

Development: directors as dictators – SHs precluded from intervening in the ordinary business of the company. This flowed from the articles of association, and contract between members of the company. SHs can control only indirectly by appointing/dismissing directors and directors have fiduciary duties towards SHs

Three theoretical models which have been “intimately embroiled in the effort of company law to justify the vesting of substantial power in corporate management:


(1) Enterprises as creatures of the state (ultra vires doctrine); (2) contractual theory (focuses on internal relations of members within the company); (3) natural entity theory/ corporate personality theory (Dicey “whenever men act in concert for a common purpose they tend to create a body, which from no fiction of law but from the very nature of things, differs from the individuals of whom it is constituted”)

Despite these three theories, there is a failure of caompny law to legitimate corporate managerial power

Necessity for a new perspective celebrating both the passivity of SHs and the way in which economic activity has come to be organized within the company rather than through the market

Analogy with the state and society is relevant, obliterating traditional perceptions of the role of the government and society, the public/private dichotomy

i.e. corporate managers’ power is legitimate because they become experts wielding power for the benefit of society generally

The Western Perspective on Law and Capitalism If we choose to explore the search for a corporatist revision in the legitimization of corporate

managerial power, then we have to accept that we are constrained by our western perspective on the role of the individual in the civil society and our public/private law dichotomy

How to define “western” view on the rule of law and capitalism that would serve to underpin theories of a new legitimacy of managerial power in corporations?

(1) Roots in the Roman societas (usually translated as partnership): embryonic version of modern corporation; (2) private area held to be superior to public, because it was in the public arena that “man is most likely to be corrupted”; (3) modern rational bourgeois capitalism appearing as a dominant phenomenon; (4) growth of exchange based on a monetary system

Differences between Anglo-Saxon and Continental Europe views on corporate governance: (1) AS: relationship between owners and managers; CE: broader set of interests to be served; (2) AS: rules primarily designed to protect owners; CE: protection of those dealing with the company takes precedence over the remedies available to SHs or managerial malpractice; (3) AS emphasized liquidity in the stock market; CE: liquidity is not an important issue; (4) AS: more adversarial model; CE: more balanced conciliatory approach.

We may, now in the late 20th century be seeing the “death” of the classical corporation, i.e. business enterprise operating in an open competitive market system free of “substantial restraints on its activities” is no longer

Conclusion We may, however, be witnessing the birth of a new form of capitalism from “advertising” capitalism

to “managerial” capitalism and finally to “investors’” capitalism The growth of corporations and the dispersal of shares has led to the compacting of individual wealth

into institutions, facilitating the transition to the third form The holdings of these institutions is so large that institutions could feasibly supervise managers in a

new system of controlThe search for a political theory on corporate governance reflects a search for comprehensive cultural ideologies of capitalism

PART 6: TAKEOVERS: THE NORMATIVE FRAMEWORK OF THE MARKET FOR CORPORATE CONTROLParallel VanDuzer Readings: Chapter 10 & Chapter 11 Part D

March 22, Class 20: How does the corporate governance regime structure the market for corporate control?This reading links the problem of corporate governance to the market for coporate control through takeovers,


drawing in some measure upon game theory.

Coffee, John C. Jr. "Unstable Coalitions: Corporate Governance as a Multiplayer Game", The Battle for Corporate Control: Shareholder Rights, Stakeholder Interests and Managerial Responsibility, edited by Arnold W. Sametz, (1991) Business One Irwin, 3.

lawyers and economists have conceived of corporate governance as basically the study of how legal and market forces combine to enable shareholders to hold management faithful to their interests. This is an oversimplification, as it leaves out an essential 3P: stakeholders. If you recognize that there are at least 3 essential players in this “game” then the familiar agent/principle model becomes inadequate as a descriptive or “positive” model of corporate governance. Must never forget that in any 3-sided game, any two players can form a coalition against the 3rd. As the takeover market has changed, stakeholders have begun to participate in corporate control contests, and seem likely to do so with even greater frequency in the future.

“stakeholder” is a deliberatively ambiguous term, which includes a variety of subgroups whose own interests can often conflict. Includes creditors, employees, unions. United by long-term interest in firm’s solvency. This implies a preference that the firm retain or re-invest much of its “free cash flow”. Free cash flow is a term that refers to all discretionary cash that remains after required payments to creditors and other fixed interest claims are settled. In contrast to stakeholders, shareholders regard free cash flow as sub-optimally invested capital, which they wish to have returned to them.

the managerial preference for earnings retention and growth may be partially explained as the product of an implicit bargain with stakeholders. Both EE and creditors have reasons to resist the shareholders’ desire to drain the firm of its free cash flow. EE have specific human capital invested in the firm, and a policy of expansion increases their opportunities for promotion advancement within the firm. For creditors, any increase in the firm’s debt/equity ratio reduces security, but in contrast, acquisitions often have a co-insurance effect that decreases the variability of the firm’s cash flow and thereby creates value for bondholders even if the acquisition is debt-financed.

problem with this is the assumption that stakeholders could have protected themselves contractually. Not clear that the right was truly bargained for, or whether it instead reflects an omission in the K that management is now exploiting opportunistically. Recognition that there may be risks that the parties did not anticipate and that the law will allocate by attempting to recreate the bargaining process does not, however, necessarily imply that bondholders win and shareholders lose. Parties do not anticipate all future contingencies, particularly in LT K, because there are inevitable cognitive limitations on the human mind’s information processing abilities. modern economic approaches to K recognize the inevitability of omission in K and recommends that the court fill in missing terms by specifying the term that it believes rational parties would have specified had they focused on the issues. Besides, contracting for remote contingencies is costly.

Beyond the fact that contracting is both costly and imprecise when remote contingencies must be provided for, and the tendency of the market to perceive such information noisily, additional problems complicate the problem of contracting with stakeholders. Even among neo-classical economists, it is recognized that long-term contracting within the corporation – whether over debt relationships, employment terms, or between classes of shareholders – falls into the special category of “relational contracts”.

Under the conventional neo-classical account, creditors and stockholders reach an equilibrium position, with management retaining some flexibility and creditors being compensated therefore through higher interest. This account assumes that anything not forbidden to management in the financial contract is permitted, and this assumption is simply at odds with the basic concept of relational contracting and with law’s general hostility to opportunism.

How do intelligent and sophisticated institutions protect themselves for the future? New investor


safeguards are appearing, including the “poison put” – this is a right given in the debt instrument to bondholders at their option to demand repayment of the full principle amount of the indebtedness (plus possibly a premium) in the event of certain occurrences, such as a takeover, restructuring, recapitalization, or merger. Note that this is not an obstacle to bidders willing to pay off the debt.

the actual extent of EE losses during takeovers is debatable, but the phenomenon of a coalition forming between management and stakeholders to resist a takeover is evident. Workers are risk-averse, and may not be willing to call a bidder’s bluff when it threatens to close a plant (etc)

With increasing but still sporadic frequency, courts have invalidated a broad range of antitakeover tactics as a breach of fiduciary duty: poison pills, lock-ups, recapitalizations, etc. But what is distinctive about stakeholder agreements as a takeover defence is that there is truly bargained-for consideration in these cases. In contrast, a poison pill is a gratuitous transfer of warrants, used by management in theory to protect shareholders from coercive offers. Yet a poison put (or similar provision in a collective bargaining agreement) was bargained for between parties that are normally at arm’s length. Because management are fiduciaries for shareholders, it is easier for a court to review this relationship than that between parties that are normally economic adversaries. (e.g. when a labour union negotiates for job security or makes its collective agreement terminate on the occurrence of a takeover or a defined share acquisition, it may be forgoing higher wages.

March 24, Class 21: What is the relationship between internal and external governance of corporate control? This set of readings presents a critical assessment of "shareholder rights plans" designed to protect corporations from hostile takeover. Different jurisdictions have taken a variety of approaches to the poison pill, and this reading allows you to situate yourself with respect to that debate.

MacIntosh, Jeffrey "The Poison Pill: A Noxious Nostrum for Canadian Shareholders" Cases and Materials on Partnerships and Canadian Business Corporations, Zeigel, Daniels MacIntosh & Johnston, Vol. 2 657

Author argues that poison pills are not in best interests of shareholders and they shouldn’t vote for them. When they do approve them, courts should carefully supervise their deployment in order the enhance the likelihood that they are used for the best interest of shareholders and not simply to entrench target managers.

Function of poison pills: two competing accounts:1. Shareholder Interest Hypothesis: hostile acquirer is able to employ coercive tactics that force

shareholders to tender into a low bid and poison pill is an antidote to this coercion. By making an acquisition very expensive, it empowers management to either defeat the bid or force a higher one or even use the time to put together a competing proposal, so shareholders will receive full and fair value for their shares.

2. Management Entrenchment Hypothesis: when successful hostile bid occurs, end result may be and often is loss of employment for incumbent managers, creating potential conflict of interest for target managers, who may be tempted to act in self-interest. Poison pill may be used abusively by management to deter or thwart hostile bids. This could result in loss to shareholders

Available evidence is that effect of poison pill is highly consistent with managerial entrenchment hypothesis.

Coffee excerpt on defensive tactics and theory of takeover: phenomenon of hostile takeovers is that bidders have been willing to pay very high premiums and there are several explanations why:1. Disciplinary Hypothesis: bidder pays a premium because it believes that under superior

management, they would earn a higher return, thereby justifying the premium.2. Synergy Hypothesis: premium justified as result of target’s having a unique value to the bidder

that is in excess of market value. Value of combined enterprise is expected to be greater that sum


of its separate parts. Subject to two objections: expected synergy seldom materializes in higher profits and theory gives little attention to disciplinary or deterrent impact of hostile takeovers.

3. Empire Building Hypothesis: under this thesis, high premiums paid in tender offers are less an indication of potential latent in target’s assets than of an optimistic assessment by the bidder of its own capabilities as manager. Suggests that most important conflicts of interest may be on bidder’s side – between interest of bidder’s management and those of its own shareholders.

4. Exploitation Hypothesis: gain to bidder can come through creation of new value or through transfer of existing value; suggestion that such wealth transfers may result from target shareholders being trapped in a classic “prisoner’s dilemma” when faced with choice between unsatisfactory current price from bidder and potentially lower price in future.

5. Overview: even though theories are inconsistent, it does not follow that on must be entirely valid and other false; each may have partial validity.

Easterbrook and Fischel exerpt on proper role of target management: tender offers are a method of monitoring work of management teams. All parties benefit from this process: target’s shareholders gain because they receive a premium over the market price, while bidder obtains different between new value of firm and payment to other shareholders. Process of monitoring by outsiders poses a continuous threat of takeover if performance lags, thus managers will attempt to reduce agency costs to reduce chance of takeover, leading to better share prices.

Arguments supporting right of target management to adopt a defensive strategy: 1. Arguments that tender offers do not increase welfare: argument relies on premise that tender

offers increase social welfare by moving productive assets to higher-valued uses and to the hands of better managers. Society benefits from active takeover market because it simultaneously provides an incentive to all managers to operate efficiently and a mechanism for displacing inefficient managers. Tender offers have been characterized as “raids” in which offeror pays a premium for a working of shares in order to loot the firm; but this is unlikely. A looter generates no new value and cannot pay a high price.

2. Argument that share price increases justify resistance from target’s management: the most plausible reason for a price increase following the tender offer’s defeat is that the market sees the defeat as simply one round in an extended auction. Many management-induced withdrawals are followed by higher offers and share prices increase as acquisition seems more likely. Regardless of cause of increase, shareholders have little cause for rejoicing. Price rise comes about because someone is taking a free rise on info generated by first offeror. Free riding reduces incentive to make the first offer; decreases monitoring and number of offers; and harms shareholders in the long run.

3. Defensive Tactics and the Business Judgment Rule: frequent consequence of a successful takeover is replacement of target managers. Given the serious and unavoidable conflicts of interest in any decision on one’s own ouster, courts ought not to make available to a manager resisting a tender offer the same deference accorded to the decision of a manager in good standing. The deference accorded managerial decisions under the business judgment rule reflects in part the inability of courts to make better business decision than managers. A rule of managerial passivity does note require courts to make business decisions at all. Under this rule, managerial decisions would be subject to attack only if designed to takeover bids.

4. Meaning of Managerial Passivity: managers must carry out corp’s ordinary business and should be able to issue a press release urging shareholders to accept or reject the offer and the offeror can also convey its view to shareholders. Management should not propose anti-takeover charter or bylaw amendments, file suits against the offeror, etc.

Gilson excerpt on a structural approach to corporations: it is argued that the problem with competitive bidding in the face of an initial offer is that the initial offeror incurs sunk costs in identifying and evaluating the target company. Competitive bids increase the likelihood that a competitor will win and incentives to make initial offers decreases.


Author finds this argument unpersuasive because sunk cost argument is understated and suspects that sunk costs are investments with a positive expected return even if the offeror is ultimately outbid. Another problem is that the argument asserting evils of soliciting competitive bids ignores the efficiency-inducing effect of price competition.

Romano excerpt on takeovers: acquisitions generate substantial gains to target company shareholders. Data is more ambiguous concerning acquiring firms’ returns.

From the acquirer’s perspective, there are two classes of explanations for a takeover: value-maximizing (takeovers undertaken to increase the equity share price of the acquiring firm) and non-maximizing ones (takeovers as transactions that maximize managers’ utility rather than stockholder wealth).

There are two efficiency explanations of takeovers: to realize synergy gains and to reduce agency costs. Expropriation explanations of takeovers focus on four distinct groups: taxpayers, bondholders, employees, and consumers.

Expropriation explanation that attracts most attention involves labour as the victim. Most sophisticated version of this theory is by Shleifer and Summers’ breach of contract explanation of hostile takeovers. In their scenario, shareholders hire trustworthy managers to make credible long-term implicit contract commitments to workers. After employees are hired, shareholders will want to breach the contract to increase their returns by lowering labour’s share and a trustworthy manager prevents this. A hostile takeover will permit shareholders to behave opportunistically and increase the value of shares because a raider will not hesitate to break implicit contracts.

Romano is not convinced because it is questionable whether workers would opt to protect themselves through implicit contract.

See CB Vol II 224 for Charts on Takeovers [AH: may be helpful but didn’t seem worth retyping, since it is clearly laid out in the text]

Daniels excerpt on contractarianism: issue of what purchase non-shareholder corporate constituencies should have on discretionary decisions of corp management has proved to be one of the most durable issues in modern corporate scholarship. The issue resurfaced in takeover wave of the 1980s.

Participants in this debate array themselves in two groups: first one which views and judicial/legislative attempt to protect stakeholders from harms not explicated prohibited by corporate contracts as anathema; and second one which regards corporate responsibility for stakeholder harms as an innate and natural feature of corporate governance. Romano attributes differences to divergence in underlying normative frameworks: for non-protectionists, it is individualistic liberalism, while for protectionists, it is communitarianism.

Within framework of law and economics, Coffee, Shleifer, and Summers, have tried to bridge the gap by advancing a rationale for protection of stakeholder interests on a takeover event that is based on implicit contractual obligations.

However, this rationale is plagued with infirmities. Its most serious defect is the assumption that takeovers constitute a unique threat to stakeholder interests.

Implicit contracts – the third way: implicit contractual analysis is able to furnish a rationale for protection of stakeholder interests upon a merger or acquisition event that is based on the parties’ actual expectations. A further benefit alleged is its ability to explain why change-of-control interests are qualitatively more destructive to stakeholder interests than are other economic dislocations.

Implicit contractual claim in favour of stakeholder protection is not uncontroversial. To succeed, its supporters must show that corp’s shareholder made promises to stakeholders to allow them to gain from a takeover; then show that these promises were meant to be enforced by legal sanctions.1. Implict contracts for gain sharing on a merger or acquisition: claim that shareholders and

stakeholder actually concluded implicit contracts is controversial. It is not that implicit contracts themselves are implausible, just that the precise promise alleged by supporters of implicit contractual paradigm is suspect.


- To enthusiasts of implicit contractarian mode, the wrong of takeovers is not that stakeholders lose, but that stakeholders lost while shareholders gain.

- There is an asymmetrical sharing of gains and losses, which is why implicit contractarians are so critical of takeovers. But normative force of sharing symmetry cracks under close examination The reasons shareholders gain from a takeover is that there are unrelated gains that are split between acquiring and target shareholders.

- The only real difference between rationalization that occurs in a takeover and non-takeover context may be the degree of crystallization of shareholder gain.

- Finally, even if shareholders suffer losses prior to implementation of rationalization program that will then inflict losses on stakeholders, there is no reason to expect that each will be commensurate with one another.

2. Implicit promises enforced by legal sanctions: to enlist the state’s assistance in enforcing these implicit promises, stakeholders must demonstrate that parties relied on legal sanctions.

Conclusion: non-protectionist argument failed for its unwillingness to take seriously the presence of conventional contracting failures; while protectionist position failed for its reluctance to consider either the actual expectations of contracting parties or efficiency consequences of across the board protection.

Examination of implicit contractual claim in favour of distinctive treatment of stakeholders following a takeover also has serious infirmities. Close evaluation of the arguments suggest that specific properties of takeover transactions do not appear to support a distinctive treatment for stakeholders.

Easterbrook, Frank H. and Fischel, Daniel R. “The Proper Role of a Target’s Management in Responding to a Tender Offer” (1982), 94 Harvard L. Rev. 1161Gilson “A Structural Approach to Corporations” (1982) 33 Stan. L.R. 819 at 870-872Roberta Romano “A Guide to Takeovers: Theory, Evidence and Regulation” (192), 9 Yale J. on Regulation 119Ron Daniels “Can Contractarianism be Compassionate?” (1993), 43 U. of T. L.J. 315

- MacIntosh and Easterbrok & Fischel: these are noxious entrenchment mechanisms- Gilson: Can encourage competitive bidding- Coffee: can provide room to take account of stakeholder interests

- idea of takeover as discipline for management seems to be a boiled down method of corporate governance

- ensures that share price goes up, therefore protects shareholders- Romano, MacIntosh, E+F – all think that takeovers are a good thing and that the market for

corporate control ought to be tailored to shareholders. - Coffee – tries to resurrect the idea that in fact the takeover setting engages stakeholders - RJR-Nabisco: was largest takeover in US history, in which enormous conglomerate was “busted

up”. Morality tale. In response to this, a few states began to adopt legislative provisions in their corporate statutes that provided protection to companies from takeovers.

- In response to these legislative measures, almost the entire corporate law academy went on a rampage to critique these methods.

- E+F, Romano – bear in mind that they are setting up an argument against what they see as a threat to the market for corporate control that was emerging.


- Delaware ultimately didn’t include these measures in its corporate law. What came in its place was self-legislation, the effort by corporations themselves to allow for (poison pills). The market responded to what was seen to be a gap in contracting – this gap is what Coffee is exploring.

- the fault lines in the argument about takeovers changes from focussing on the big bad state interfering in corp control to whether corporations themselves should interfere in this.

- this put some commentators, like MacIntosh, in the embarrassing situation of having to examine the market response to the problem.

- the emergence of shareholder rights plans, which are adopted by shareholders, - MacIntosh frames his critique as a plea to shareholders not to go along with this… wants

legislation to block poison pills

PART 7: THE GLOBALIZED FIRM: MULTINATIONAL CORPORATIONS AND NETWORKED FIRMSNo Parallel VanDuzer Readings

March 22, Class 22: What are the legal implications of the multinational and transnational firm?These readings identify legal issues associated with the multinational corporation. The issues are by now familiar from your other readings, but simply take on a transnational dimension. Thus, for example, where is the legal personality of the transnational firm and how do overlapping corporate governance regimes interact?

Pauly, Louis W. and Reich, Simon "National structures and multinational corporate behaviour: enduring differences in the age of globalization" International Organization 51 (1997) 1Pauly and Reich “National Structures and multinational corporate behaviour: enduring differences in the age of globalization” International Organization p.231-246 Liberal and critical theorists alike claim that the world political economy is becoming globalized BUT recent evidence shows little blurring or convergence at the cores of firms based in Germany,

Japan or the US This article shows that MNCs continue to diverge fairly systematically in their internal governance

and long-term financing structures, in their approaches to R&D, as well as in the location of core R&D facilities, and in their overseas investment and intrafirm trading strategies. Durable national institutions and distinctive ideological traditions still seem to shape and channel crucial corporate decisions; foundations of corporate markets are not converging. Markets in this sense are not replacing political leadership and the necessity for negotiated adjustments among states

Analytical context The MNC, is central to a number of contemporary research programs in the fields of international

relations and international political economy Relying on the assumption that the logic of globally integrating markets ultimately drives corporate

behaviour, two important bodies of theory are evolving: (1) liberal tradition: increasingly mobile capital and the necessary responsiveness of firms to cross-national technological and financial incentives are beginning to constrain even leading industrial states and their societies in broadly comparable ways; (2) critical theorists: socioeconomic phenomenon of “globalization” is leading to a noose, woven in substantial part by MNCs, tightening around the neck of traditional forms of national political organization. These two theories are really the same.

This article cuts into the middle of this argument and explores the counterintuitive proposition that leading MNCs are not converging towards common patterns of behaviour at their cores

My thesis: the institutional and ideological legacies of distinctive national histories continue significantly to shape the core operations of multinational firms based in Germany, Japan and the US


The direction of causation between the legacies of distinctive national histories, the core structures of firms, and important firm strategies is not a simple matter (note: the article does not address specific governmental policies responding to or seeking to affect corporate behaviour)

Argument Certainly firms must continuously adapt to dynamic markets in order to survive, and certainly that

adaptation must now take place in a world where short-term capital is highly mobile and where certain technologies are changing quite rapidly

But the underlying nationality of the firm (given by historical experience and the institutional and ideological legacies of that experience) remains the vitally important determinant of the nature of its adaptation

Therefore there are systematic and important national differences in the operations of MNCs: internal governance, long-term financing, R&D, intertwined investment and trading strategies

National structures retain their priority wrt other factors currently reshaping the wold of the modern corporation

Our theoretical approach is as follows: (1) states are understood as institutional structures, and basic institutional structures of MNCs may be influenced or even determined by the characteristics of states; (2) the institutions worth emphasizing should be seen as embodying durable ideologies that link states and firms in distinctive ways; (3) those institutions and ideologies may be viewed as dynamic, but the change much more slowly than the firm-level operations rooted within them

Ideologies can be understood as “collective understandings” of roles, beliefs, expectations and purposes

US Germany JapanPolitical Institutions Liberal democracy

Divided governmentHighly organized interest groups

Social democracyWeak bureaucracyCorporatist organizational legacy

Dev’tal democracyReciprocal consent between state and firms

Economic Institutions Decentralized, open marketsUnconcentrated, fluid capital marketsAntitrust tradition

Organized marketsTiers of firmsBank-centred capial marketsUniversal banksCertain cartelized markets

Guided, bifurcated, difficult-to-penetrate marketsBanks centred capital marketsTight business networks/cartels in declining industries

Dominanct economic ideology

Free enterprise liberalism

Social partnership Technonationalism

The putative relationship between domestic structures in table above and core aspects of multinational corporate behaviour is not spurious

Empirical Evidence Corporate Governance and financing

o US corporate managers are highly constrained by dynamic and deep capital markets: 90% of shares of publicly listed corporations held by individuals, pension funds and mutual funds. Banks held less than 1%. Nonfinancial firms held a negligible number of shares. Focus on short-term share value

o Japanese corporate managers are effectively bound by complex but reliable networks of domestic relationship. 30% of shares of publicly listed corporations held by individuals, pension funds and mutual funds. Banks held about 25%. Quality products, market share and employment are also legitimate goals as well as return on shareholder investment – shares a more long-term, durable Nonfinancial firms held 25%.


o German corporate managers retain a relatively high degree of operational independence. 15% of shares of publicly listed corporations held by individuals, pension funds and mutual funds. Banks held about 10%. Nonfinancial firms held 40%. Quality products, market share and employment are also legitimate goals as well as return on shareholder investment – shares a more long-term, durable.

o Relationship between banks and corporations: US: banks provide secondary financing; Germany and Japan: banks perform a steering function

o Japan: lots of cross-shareholding (I’ll hold your shares and you’ll hold mine); also, managers are constrained by their bankers and by the firms to which they supply key components – arm’s length relationships are not the norm

o Germany: supervisory boards of German MNCs reinforce the functions of banks, by holding ~10% of seats on supervisory boards, and sometimes by having the bank provide the board chairman.

R&Do US, Germany and Japan tend to maintain their basic R&D operations at home; Japan

most reluctant to shift R&D activities abroad and Germany least reluctanto Japan: in hard times, cuts to R&D budget is a last resort; US and Germany spend lower

percentage on R&D Investment and intra-firm trade

o US MNCs rely much less than their rivals on intrafirm and intra-affiliate trading (IFT), with foreign direct investment strategies broadly based on and reflective of the expectation of competitive inward flows, and willingness to outsource some key parts of production

o Japan: heavy reliance on ITF, and strong outward orientation from a home base that is secure from external challenge (i.e. intrafirm exports)

o Germany: also outward orientation(i.e. intrafirm exports), and heavy reliance of ITFConclusion There are remarkably enduring divergence across Germany, Japan, and the US in patterns of internal

governance and long-term financing, R&D, and investments and IFT Evidence suggests a logical chain that begins deep in the idiosyncratic national histories that lie

behind durable domestic institutions and ideologies and extends directly to structures of corporate governance and long-term corporate financing

Those structures in turn appear plausibly linked to continuing diversity in the corporate foundations of national innovation systems and in the varying linkages between foreign direct investment and IFT strategies

Because the general lines of demarcation are national, the proposition that those syndromes are durably nested in broader domestic institutional and ideological structures cannot easily be dismissed

Three important implications: Since MNCs are key actors in the dev’t and diffusion of new technologies, their national rootedness

appears to remain a vital determinant of where future innovation takes place The globalization template upon which much current theoretical and policy debate rests remains quite

weak With respect to the growing debate as to whether markets are replacing states as allocators of public

values, our evidence does not speak directly to this debate, but suggests that for leading societies any such shift is primarily an internal matter

Mabry, Linda A. "Multinational Corporations and U.S. Technology Policy: Rethinking the Concept of Corporate Nationality" 87 (1999) Georgetown Law Journal, 563

conflict between globalism and nationalism one of the defining issues of our time.


American law has traditionally considered that corporate nationality has been determined by reference to either a company’s place of incorporation or the nationality of its owners, managers, or other persons deemed to be in control of its affairs—the “control test”

author thinks under current paradigm, it would be more appropriate to talk about an “economic commitment test” in which a corporation’s national identity would be determined by reference to structural, organizational, and operational features of the firm (e.g. nature + geographic location of assets, geographical sources of earnings, relationships w/ 3P contractors outside US)

MNCs (as we know them now) did not appear until the mid-19th C when advances in tech, manufacturing, and management processes made possible the international division of a firm’s production. As of 1999, according to UN estimates, there were over 35, 000 MNCs. In the early 20 th-C, most were British; post-WWII they were American; in the 60s, started having MNCs from Europe and JPN; recently there are some from Korea, Mexico, and Brazil.

most early MNCs were resource-based companies involved in the extraction and production of natural resources incl oil and minerals, or in the manufacture of products based on tropical agricultural commodities. Post-WWII, focus shifted to establishment of advanced tech and service operations in other developed countries.

expansion strategies and organizational structures of MNCs have undergone major changes since these enterprises first emerged. Whereas initially overseas operations were limited to final assembly, sales and marketing, and after-sale service and maintenance by the 1970s increasing numbers of foreign MNCs had taken over complete manufacture for local markets. Now, foreign subsidiaries are used as R&D centres; and production, design, and innovation centres.

these trends have been driven by the growth of regional trading blocks, the decrease in product lifecycles, the global diffusion of tech expertise, and the need to launch new products simultaneously in all major world markets in the high-tech industry.

today, recognizing that regional and global firms are better able to move huge volumes of goods more quickly and most cost effectively, some MNCs are integrating their previously nationally focussed and autonomous production and distribution operations in various countries along regional and global lines.

MNCs in some industries delegate functions that previously were performed by either the parent or a foreign affiliate to 3P contractors in foreign countries, mostly in the developing world. This has created the “Global Commodity Chain” which can be producer-driven (PDGCC) or buyer-driven (BDGCC). PDGCCs are generally found in capital- and technology-intensive industries, such as automobiles, etc. BDGCCs are usually found in labour-intensive, consumer-driven areas like garments, footwear, toys, and consumer electronics. What is distinctive about BDGCCs is that the core companies do not own any production facilities.

Currently, the development of MNCs is accomplished not only by national firms establishing new, wholly-owned subsidiaries in foreign markets, but also by international merger and acquisition and portfolio investment transactions. The emergence of international capital markets has given MNCs both the incentive and the means to place shares with foreign investors. In addition, firms are merging with or acquiring foreign firms that can provide access to technological resources or to global production distribution networks.

an increasing number of companies are entering into “international strategic alliances” which are collaborative arrangements through which firms spread the risks and costs of R&D and new product development, etc (similar to joint ventures, involves lots of sub-contracting, cross-licensing, tech exchange agreements and minority stakes).

some observers have noted the emergence of “global corporations” which have a number of distinct characteristics including (i) sells its products in each main world market and derives a substantial amount of its revenues from activities outside the home country market; (ii) many assets located in foreign markets; (iii) owns/controls foreign affiliates in each major economy; (iv) nationally diversified workforce at entry level, incl management; (v) managers typically rotate through different


foreign postings and often are more strongly identified with corporate culture than home culture; (vi) no presumption in favour of home market in decisions regarding location of operations

e.g. of global corporation = Asea Brown Boveri (ABB) which was originally Swedish. 85% of sales made outside of Sweden; 50% of shares held outside of Sweden; 18,000 employees working in 40 different countries; official language = ENG but that is native to only 1/3 of the EEs; headquarters in Zurich staffed by 19 different nationalities, but hq kept small to avoid appearance of Swiss company.

Muchlinski, Peter Multinational Enterprises and the Law, (1996) Blackwell Publisher’s, 12

Problems of definitions: economists have favoured a single all-embracing formula, defining as a multinational enterprises (MNE) any corp which owns, controls, and manages income generating assets in more than one country; a firm that engages in direct investment outside its home country.

UN has moved away from this simple formula towards a distinction between multinational corporations (MNCs) and transnational corporations (TNCs). They adopted definition of MNCs as enterprises which own or control production outside the country in which they are based. Some members preferred the term TNC, which it was said better expressed essential feature of operation across national borders than did multinational. The UN subsequently adopted the term transnational.

The crucial characteristic of the MNE is the ability of one company to control the activities of another company located in another country.

Though in many respects, MNEs differ in their capacity to locate productive facilities across national borders, to exploit local factor inputs, thereby to trade across frontiers in factor inputs between affiliates, to exploit their know-how in foreign markets without losing control over it, and to organize their managerial structure globally according to the most suitable mix of divisional lines of authority. These factors permit them to affect the international allocation of productive resources, and thereby to create distinct problems in the development of economic policy in the states where they operate.

They should be treated as a distinct type of enterprise for the purposes of economic regulation. The role of legal factors: in relation to ownership- or firm-specific factors the most significant

function of capitalist legal systems is to facilitate the creation and exploitation of such advantages by firms, including the MNE.

Of particular importance is the protection of the firm’s innovations and brands and then the creation of structures conducive to the growth of large corps. A system of patent law ensures the protection of the firm’s competitive advantages by granting a monopoly for a specific time.

To the extent that size is a contributing factor to multinationality, legal conditions that permit the growth of large corps can be seen as instrumental in the growth of MNEs.

Modern company law has evolved in a manner especially conducive to large-scale business, especially the acceptance of the holding company concept, which made merges and acquisitions much simpler. But corporate legal form is now a sufficient element for growth; economic factors have been primary stimulants to the development of large corps.

The role of legal factors in the growth of large enterprises should be seen as being one of having influenced the form but not of causing their influence. However, there may be significant legal issues related to the regulation of the particular industry or country in which the firm operates that contribute to overall patterns of competition in relation to which the MNE functions

Locational factors: there is little doubt that legal factors form an important category of locational factors designed to facilitate the achievement of economic goals. In theory, the state may use its political power to alter its locational advantages and thereby influence the investment decisions of MNEs.

Internalization factors: legal aspects of internalization advantages in MNE growth raise perhaps the most conscientious issues. The ability of a MNE to take advantage of differences in regulatory environments between states is seen as one of its internalization advantages. The resulting potential for the ineffectiveness of national regulation over the activities of MNEs has led certain states to


apply their laws extraterritorially to non-resident units of the MNEs operating within their jurisdiction. The consequence has been to encourage conflict over the exercise of such jurisdiction between the regulating state and the state in which the targeted MNE operates.

The conflict caused by uncoordinated unilateral state policies has led to attempts at greater international cooperation in regulatory matters and at the evolution of an international consensus over standards to apply to regulation of MNEs.

The development of a genuine international law of foreign direct investment would serve to reduce the internalization advantages of MNEs as a result of diversity in national regulations, through the harmonization of state policies and it may not be politically feasible.

The advantage enjoyed by the MNE over domestic firms as an exploiter of labour will depend to a significant degree on the legal conditions regarding labour relations that are imposed on it by host states: responses of countries vary from protection of union rights to outright repression.

Concluding remarks: our understanding of the contribution of legal factors to the growth of MNEs is even less advanced than economic theory. Further research is needed.

Legal forms of multinational enterprise: MNE legal structures divided into categories:1. Contractual forms: where international business is carried on by means of contract, there may

emerge a relationship of control and dominance by one party which creates a degree of business integration that would come within definition of MNE. - Contractual linkages can be divided into those aimed at distribution (simplest form arises

where a producer in the home state enters into a distribution agreement with a distributor in the host state) and production (if overseas demand for a product manufactured in home state make overseas production desirable, contractual options, such as licensing, present themselves).

- Most advanced contractual form of MNE is international consortium, which is defined as an organization created when two or more companies co-operate so as to act as a single entity for a specific and limited purpose. Such forms are most often used for specific, large-scale construction or engineering projects.

2. Equity based corporate groups: most commonly held image of MNE is of a closely controlled group of companies linked by shares by the parent company and its intermediate holding companies. But this fails to describe the variations between groups from different countries.- Anglo-American pyramid group: this structure consists of a parent company which owns and

controls a network of wholly or majority-owned subsidiaries, which may themselves be intermediate holding companies for sub-groups. Resulting structure is a pyramid with parent at apex. It is especially typical of US and UK MNEs.

- European transational mergers: these structures represent a border between corporate groups headed by one parent and joint ventures between independent companies. This is especially common in Europe, where the integration of national companies across borders into larger enterprises is well established.

- Japanese keiretsu: legal character of these corporate groups is strongly influenced by requirements of Law on Prohibition of Private Monopoly and Ensuring of Fair Trade (Anti-Monopoly Law). As a result of these provisions, Japanese groups have evolved unique structures to avoid the prohibitions. They are characterized by small, intra-group cross-shareholdings coupled with strong coordinated management.

- These equity structures have developed around groups that were initially national firms but that expanded abroad, and as such, they represent the legal forms of developing MNEs.

- Once firms become established, the major pressures are towards the maintenance of global competitiveness through increased international coordination and local responsiveness.

3. Joint ventures: this can refer to any agreement or undertaking between two independent firms. Some features associated with this concept: it involves the cooperation of two or more otherwise independent parent undertakings which are linked, through venture, in the pursuit of a common commercial, financial or technical activity. It usually involves shared control by parent


undertakings. It may take the form of a contract, partnership or limited liability company. incidence of international joint ventures between firms from more than one country is common.

4. Informal alliances between MNEs: inter-corporate alliance will take the form of a transnational merger where the parent firms wish to fully integrate their business operations. Contractual route is most likely where the alliance is set up for specific commercial aim, which does not involve a high level of integration between parties and where risks are small enough not to require limited liability.

5. Publicly owned MNEs: despite emphasis on privatization, there are sufficient numbers of MNEs that are either partly or wholly state-owned. They can arise either through a state-owned enterprise adopts a strategy of international expansion or an existing MNE is nationalized. Principle question affecting legal structures here is the relationship between the state and enterprise and the degree of control that the former wishes to exercise over the latter.

6. Supranational forms of international business: these entities are formed under laws adopted by regional organizations of states, aimed at furtherance of cooperation between firms from more than one member state.- Forms adopted by EC: European Economic Interest Group (EEIG) seeks to create a

supranational form of business association that will facilitate cross-border cooperation between business entities operating within the EC. It is disqualified from certain commercial activities, such as being used as a holding company for the members and must not employ more than 500 persons. It is most likely to be used for joint R & D or distribution and has proved popular for creating transnational legal practices.

- The Andean Multinational Enterprise adopted by the Andean Common Market (ANCOM): in 1980s ANCOM introduced the Andean Multinational Enterprise (AME) as a means of creating supranational regional enterprises aimed at the furtherance of joint industrial development. Its legal form is that of a company with capital contributions from national investors. It is entitled to special treatment under the laws of member countries, including national treatment; free circulation of capital contributions; free import and export of goods that are part of capital contribution, etc.

- Public international corporations: this is set up by two or more states through an international treaty and will perform specific economic function that is of importance to public policy of founding states, that can be better carried out with intergovernmental cooperation (e.g. satellite communications). Essential difference between this and MNE is that the former will be governed by a regime based on its constitutive treaty rather than on any system of national law.

Concluding remarks – business and legal forms and the control of MNE activities: MNEs have outgrown that simple managerial structure of the entrepreneurial corporation and have reorganized along divisional lines of control based on managerial functions, products, and areas of operation.

What may be needed is a radical rethinking of the very legal forms themselves and their replacement with new legal forms better able to correspond with the decision-making boundaries of firms.

Two approaches can be identified: structural (reformed in such a way that it more closely corresponds to its business organization and ensures the existence of a relevant unit for accounting, fiscal, and other regulatory purposes; and operational (increasing obligations placed directly upon establishments within the group, such as an accountable business activity concept, whereby managers would be responsible for disclosing info).

Jurisdictional levels of regulation: international scope offers in theory a choice between three levels of regulation: national, regional, and international. 1. National regulation: this is the most significant level; emergent regional and international

regulatory orders are still insufficiently developed to replace the nation state as the principal focus for regulation of MNEs. States tend not to consider the impact of their regulatory policies on the economic welfare of other states. Unilateral national regulation tends to create a global market divided by different policy regions, leading to distortions in investment patterns.


Principle legal problem of unilateral regulation by the state arises from fact that MNEs operate across the limits of national legal jurisdiction. Legislature may wish to prescribe laws that apply to the whole of the MNE group regardless of its presence in another jurisdiction, but issues of extraterritorial application of law can have serious political effects.

2. Regional regulation: an alternative is that states with common economic interests in a coherent geo-political region can form a joint economic organization for the coordination of their economic policies, such as free trade. In relation to MNEs, such a development has the advantage of creating a harmonized economic policy area in which MNEs can organize their international network without having to confront differences in regulatory regimes, resulting in economic efficiency. Regional approach should increase bargaining power of individual states through collective action and this approach may grow in significance.

3. International regulation: neo-classical economic analysis points to the development of international regulation as the most efficient solution to the control of MNEs. The area of control would coincide with the global market, allowing for progressive removal of national regulatory barriers to foreign investment and competition would be assured. Incentives for MNEs to exploit differences in national regulations could be removed by harmonization of tax laws, disclosure standards, etc. Such a system would require the establishment of multilateral institutions that would develop and police the system. - This type of model has been challenged by international model that seeks to protect host

sovereignty in the control of foreign investors. The assumption being that MNEs have the power to undermine economic policies of weaker states, so such states need to have political power enhanced through international law.

- The liberalization model, favoured by major home states of MNEs, sees international law as a system for the restriction of state power where this exercise can lead to distortions of the global economy.

- Debate over appropriate international regulatory model is by no means over, as there remains considerable reluctance on the part of states to part with their sovereign powers, even in the face of an increasingly international economy, where the economic and social success of a state is closely related to the development of beneficial relationships with MNEs.

Concluding remarks: author just gives an overview of all 17 [!] chapters of the book.

March 24, Class 23: What are the legal implications of transnational strategic alliances and networked firms?To this point we have considered the firm as a discrete entity. Yet, the contemporary globalized firm is more often than not part of a web of relationships among firms and thus itself involved in multi-party governance structures. Autunes present a sophisticated understanding of the legal problems raised by the networked corporation. Castells puts this phenomenon into historical context and Evans and Wurster discuss the implications of the "new economy" for the corporate form. The Figure gives an example of a complex alliance arrangement.

Autunes, José Engrécia Liability of Corporate Groups – Autonomy and Control in Parent-Susbidiary Relationships in US, German and EU Law – An International and Comparative Perspective, (1994) Kluwer Law and Taxation Publishers, 13, 99I. The Corporate Group as an economic Phenomenon: from the Atomistic Era to the Molecular Era of Corporation LawA. The Classical Atomistic Era of Corporation Law: The Paradigm of the single-corporate enterprise1. The Classical Atomistic Vision of Corporate Law Corporation law is, in its ancestry, the law of the individual autonomous corporation Traditional corporation law regulates business enterprises according to the presupposed model of the

single and autonomous corporation


It works on the assumption that the corporation is an independent legal and economic entity, enjoying a sovereign power of self-determination emanating from a myriad of individual powerless shareholders which would guide the ultimate destiny of the corporation (volonté sociale), administered by independent managers entrusted with fiduciary duties who would run corporate affairs in pursuit of the best business interests of the corporation itself (intérêt sociale), and kept strictly closed off against any possible interference from its environment

In a positive sense, this assumption explains why the object of corporate law has traditionally been restricted to the regulation of the formation, organization, management, financing and dissolution of the corporation as an entity.

In a negative sense, it also explains why an entire phenomenology of modern corporate life – consisting essentially of the problems raised by corporate groups (intercorporate control relationships) – has traditionally been ignored.

This is the atomistic vision of the economic and business world2. Historical, economic, political and legal foundations of the classical vision The atomistic view is the direct outcome of converging and interdisciplinary influences exercised by

the 19th century historical and ideological (economic, political, legal) environment The historical environment

o The economic world was a world of small firms engaged in a local and one-product market, normally possessing no business relationships with commercial partners and holding no significant market share.

The ideological environmento Economics: (a la Adam Smith) the global economic order conceived as a system

anchored in the principles of free competition and open market. The economic world was thus viewed as a system composed of individual and equal-sized units, enjoying an absolute autonomy between themselves

o Political/social: liberal ideology complemented the economic ideology. Based on intense individualism

o Legal: codification era gave juridical expression and condinuity to this “methodological individualism.” Polarity between the state and society (i.e. the economy), led to the entire sense and construction of private law.

B. The Emergence of the Molecular Era of Corporation Law: The New Paradigm of the Polycorporate Enterprise1. The Rise of the Modern Polycorporate Enterprise Two main factors are responsible for a complete change in the atomistic state of affairs: economic

concentration wave; and the juridical admission of corporate ownership of the shares of other corporationsIndustrial Capitalism, Enterprise Concentration, Corporation Law

Business was increasingly conducted by large-scale enterprises, operating typically through numerous incorporated business subdivisions – especially manufacturing

Modern enterprises show a natural tendency to their own growth and the economic system as a whole, by contrast with the classical hypothesis of the atomicity of economic actors, manifests an irreversible propensity to become a process of aggregate enterprise concentration: Primary concentration (getting bigger, mergers of firms in the same industry) and secondary concentration (polycorporate enterprise, but in order to avoid the organizational, financial and legal risks associated with being a single entity, a corporation would often seek for the economic or legal control of other firms)

This also meant movement from the market model to the hierarchy model (Coase)Intercorporate Stock Ownership: the Revolution in Corporate Foundations


The polycorporate form was not only the outcome of an economic evolution; it was also a direct result of fundamental legal changes in corporation laws: legitimation of the intercorporate stock ownership device by positive law allowed corporate groups to form

2. The Polycorporate Enterprise in Today’s Corporate WorldThe Polycorporate Enterprise in the International Arena: EU, US and Japanese Markets

Protagonist of the polycorporate enterprise: MNC However, the legal literature has only occasionally taken into account the importance of the

organizational patterns of such enterprises for its own purposes and drawn from there the necessary conclusions

As “creatures of private corporate law” MNCs represent nothing but multi-corporate groups or polycorporate networks exercising a unitary business activity in several different countries

The prominence of polycorporate networks can be appreciated through three different dimensions: (1) the diffusion of multinational corporate groups (i.e. sheer increase in number of them); (2) the typical configuration of its structure as a multi-corporate network (impressive number of inter-corporate linkages (parent-subsidiary, associated, trade investment etc), and EU corporations have more links than US ones, also many dormant corporations, i.e. ‘empty subsidiaries created by the parent for purely organizational reasons like tax); and (3) the power it exercises in the context of the world economic system (turnover = 30% world GDP; employ huge numbers)The Polycorporate Enterprise at the National Level

Growing networks of corporations at the national level tooC. What is Left From the Classical Economic Model? Corporate law evolved upon a curious mix of economic foundations On the one hand, it was built in accordance with the model of an autonomous closed and single entity On the other hand, business realities soon evolved in a completely opposite direction Emerging in an atomistic economic environment and profoundly derived from a deep-seated

individualistic approach to business realities, corporate law’s classical paradigm has been one of the single corporate enterprise. However, providing a unique device for the concentration of economic power and the operation of the capitalist system, it played a strategic role in the dev’t of a completely different economic order, that gave rise to a new paradigmatic and competing actor: the polycorporate enterprise

II. The Corporate Group as a Legal Phenomenon: The Crisis of Classical Legal Model of the CorporationA. The Classical Legal Model of the Corporation1. The Model and its Dogmatic Foundation: The Institution of Legal Personality As a unique concentration device of patrimonial, financial, labour and organizational structures, the

corporation rose not solely as one type of company amongst others, but truly as the “prototype of the company”

The corporation sprang up, under the pressure of economic facts, in the world of law: it got legal personality

2. Corporate Groups and Autonomous Organizational Structure of the Corporation Contrary to natural persons, legal persons are unable to perform by themselves their own set of rights

and duties, which explains their need for an organization: decision-making structure, and the outside representation of the corporation before third parties

Corporate law as constitutional law: Like any other collective institution (state, church) the corporation cannot live without the prior constitution of a decision-making structure

An enormous gulf between law and reality has been introduced in this classical legal model by the reality of corporate groups (reality: passive shareholders, emptying of powers of shareholders, heterogeneity between control capital and investing capital, progressive concentration of governance power in the hand of a technostructure rendered inevitable by the growing complexity and specialization of management skills on large business undertakings)


Contrary to the received legal model, the central core and sovereign organ of the corporation is management, however such sovereignty itself will always and necessarily be a limited one

The gulf between law and reality is true also regarding the functioning of the corporate organs: the notion of the “corporate interest” is well entrenched, but as soon as a corporation becomes member of a corporate group, its own ‘interest’ is inevitably condemned to pass to the background, as the global interest of the group takes precedence; the notion of shareholders’ equal treatment becomes totally fictitious due to certain effects entailed by the polycorporate structure, such has the creation of a basic heterogeneity between shareholders and the subordination of the interests of each constituent corporation to the group general interest.

C. What is Left from the Classical Legal Model? The emergence of the corporation not only brought about a revolution in the economic foundations of

corporation, replacing the old 19th century paradigm of the single-corporate enterprise; it also induced a crisis in the very core of the legal foundations of this branch of law

The corporate entity is often nothing but a junior constituent of a vast polycorporate cluster within which a unitary business enterprise has been split up, whose economic activity is not obviously pursued in the execution of any inner power of self-determination, nor in the prosecution of its own business interest

Therefore, all the essential features of the classical legal model of the corporation were submitted to a sever scrutiny by corporate groups

With the rise of corporate groups, the gulf between law and reality ecomes possibly the largest ever in the history of corporation law

Castells, Manuel The Rise of the Network Society, 2nd ed., 206

Williamson’s influential interpretation of the emergence of the large corporation as the best way to reduce uncertainty and minimize transaction costs, by internalizing transactions within the corporation, simply does not hold when confronted with the empirical evidence of the spectacular process of capitalist development that took place in the Asian Pacific between the mid-1960s and early 1990s.

In most of the literature of the past 20 years, it seems as if the MNE, with its divisional, centralized structure, was the organizational expression of the new, global economy. The only debate was whether these entitites were still linked to their countries of origin or whether they were truly trans-national (i.e., have they superseded their national origin?)

author claims that empirical analysis of both theories demonstrates that both those ideas are wrong, and the predominant organizational form of international business is the network

Dieter Ernst has found 5 different networks: supplier networks; producer networks; customer networks; standard coalitions (initiated by potential global standard setters with the explicit purpose of locking-in as many firms as possible into their proprietary product or interface standards); and technology cooperation networks.

networks are either centered on a major MNE or are formed on the basis of alliances and cooperation between MNEs. Oligopolistic concentration has been maintained or has increased in most sectors of major industries, not only in spite of but because of the networked forms of organization.

MNEs are still highly dependent on their national basis MNEs are increasingly organizing themselves into decentralized networks MNCs are indeed the power-holders of wealth and technology in the global economy, since most

networks are structured around such corporations. But at the same time, they are internally differentiated in decentralized networks, and externally dependent on their membership in a complex, changing structure of interlocked networks.

the organizational effects are exactly opposite what would be expected by traditional economic theory: while market size was supposed to induce the formation of the vertical, multi-unit


corporation, the globalization of competition dissolves the large corporation in a web of multi-directional networks, which become the actual operating unit. The increase of transaction costs, because of added technological complexity, does not result in the internalization of transactions within the corporation but in the externalization of transactions and sharing of costs throughout the network, obviously increasing uncertainty, but also making possible the spreading and sharing of uncertainty.

the architecture and composition of business networks being formed around the world are influenced by the national characteristics of societies where such networks are embedded. The network enterprise is increasingly international (not trans-national) and its conduct will result from the managed interaction between the global strategy of the network and the nationally/regionally rooted interests of its components.

Evans, Philip and Wurster, Thomas S. Blown to Bits – How the New Economics of Information Transforms Strategy, (1999) Harvard Business School Press, Boston, Mass, 193

Business organization is deconstructed as the trade-off between richness and reach blows up. New organizational models become possible and afford much more richness and reach.

Shifts in the richness/reach trade-off has enable substantial deconstruction of investor relationships. Deconstruction is beginning to reshape labour markets.

Traditional hierarchical organization: it can be slow, cumbersome, bureaucratic, and politicized, but it remains the basic model of how economic activity is organized.

Traditional organization is built on severe constraints imposed by trade-off between richness and reach. The economics of information has always been determined in part by the economics of the physical entities that the organization has existed to manage (e.g. why offices are located next door to factories).

Resulting trade-off has made it more difficulty to move information around. Hallmarks of classical hierarchy - division of labour, accountability, discipline, etc. – are all consequences of the trade-off.

Traditional organization has layers of middle managers switching info up and down. The classic hierarchy supports rich coordination within a reach defined by common reporting relationships.

Problems of coordinating a hierarchy are reduced to the extent that it is possible to break down the overall business into tasks that have as little to with each other as possible. The problem of hierarchical organizational design is one of partitioning the managerial task into as discrete and independent a set of tasks as possible, then building a fixed set of information channels that support the partition.

The trade-off results in asymmetries of information. Senior executives have a more comprehensive grasp of the big picture, while subordinates have detailed knowledge of their respective departments. This asymmetry requires complex structures to maintain control.

Asymmetries of information imply asymmetries of power. To minimize politicization, the traditional organization emphasizes formality, discipline, and impersonality. Commitment to the company, integrity, and fairness are key parts of the value system.

Markets and hierarchies: traditional hierarchies support richness but lower reach; markets support higher reach but lower richness.

Hierarchies encourage collaboration: people work together without having to negotiate responsibilities and rewards because it is the common employer who bears the risk.

In markets, every contingency in the collaboration has to be negotiated (no third part to bear the upside and downside). But by minimizing informational and moral interdependency and concentrating risk and reward, markets make initiative easier and more rewarding. The choice between markets and hierarchies is thus a trade-off between collaboration and initiative.


Hierarchies are amenable to leadership and strategy, while markets generally are not. Hierarchies can exploit nonlinearities, while markets adapt incrementally and without political complexities of hierarchies.

As new organizations create market-like mechanisms internally and collaborative mechanisms externally, these distinctions break down. Hybrids have emerged that achieve more richness and reach, a better trade-off between collaboration and initiative, and a better balance between strategy and adaptability.

Hierarchical organization has served a purpose: it has provide an effective solution tot informational constraints that technology or its limits imposed on large enterprises.

PART 8: CORPORATE SOCIAL RESPONSIBILITY: FROM LEGITIMATE GOVERNANCE TO RESPONSIBLE CITIZENSHIP

Parallel VanDuzer Readings: Chapter 12

March 29, Class 24: What is the legal foundation of corporate social responsibility and corporate citizenship?We have studied the corporate constitution in comparative and transnational perspective. The corporation, originally a creature of the state, wields authority within the corporate governance regime that has at times dramatic social and political implications To raise the question of the social responsibility of the corporation is itself controversial. These readings do so, documenting both the law’s function and the pattern of corporate practice.

Jacoby, Neil H. A Blueprint for the Future, Macmillan Publishing Co., Inc., New York, 165

American corporate government is often branded as antidemocratic, irresponsible, and ineffective. (for succinct overview of general complaints see pp. 321-22 – review, so I’m not bothering to reproduce here. Also, note this article is probably from the mid-1970s but no date indicated)

the weak influence of stockholders upon corporate behaviour is another standard subject of censure. Stockholders are seen as faceless and impotent, while top managers are seen as self-perpetuating, irresponsible “power elite”

criticisms generally reflect the viewpoint that the American corporate constitution is defective and that government should intervene to correct its faults. The real “constitutional crisis” of the corporation is whether the actual power and authority relationships in today’s big companies are radically different from those contemplated by legal theory.

Although US corporate charters fix precisely the powers of shareowners and directors, and thereby determines the relationship between them, it leaves open the relationship between the BOD and the management. The responsibilities of directors of big companies are onerous. While some companies carry insurance against the legal liabilities of their directors, its coverage is partial and leaves a director exposed to heavy personal damages if it can be shown that he was careless in making a bad decision.

the business corporation is a task-oriented, efficiency-seeking, profit-motivated institution, operating in an unstable environment of rapid technological change. The outcomes of decisions made by the BOD are usually laden with uncertainties. Corporate government requires rapid responses to changes in the business environment. Instability of the business environment requires that the government of corporations be different from that of other social institutions, for which stabler environments allow more leisurely decision-making processes. This instability is the reason why authority to govern the company is concentrated in the BOD, representing a single constituency – the shareholders – and able to make decisions on one criterion – the shareowners’ interests.


although the corporate charter has traditionally been considered perpetual, except for those states that limit charters specifically, some think that charters should be limited, and that corporations should be obliged to demonstrate that they have been operating in the public interest (like TV and radio broadcasting companies) in order to be renewed.

those who would limit the duration and the activities permitted by the corporate charter overlook the fact that market competition and governmental regulation now tend to assure that enterprises serve the public interest. Competition can assure the public that the products it demands are available at the lowest prices, and that employees are provided with jobs at the highest wages. It can provide suppliers with the best prices for their products. When competition alone does not adequately protect the public interest, governments regulate business through a battery of boards and commissions. To restrict the permissible types of business activity in the charter would be to restrict freedom of enterprise and to impair the vigour of competition.

those who would restrict corporate charters misconceive the function of corporate laws, which is simply to define the conditions under which persons may associate for common business activities. Such laws are not intended to be – and should not be made into – omnibus regulatory statutes. The present liberal grant of power in corporate charters is in the public interest.

the case for the multi-interest BOD was first stated uncompromisingly by Scott Buchanan. The basis of B’s reasoning was Hobbes’ observation in Leviathan that corporations are “chips off the block of sovereignty”. Buchanan understood this to mean that corporations are private governments. As such, he argued, they should meet all the tests of healthy governments, namely, republican form and democratic process.

Buchanan’s concept of “democratized” corporate government must be rejected on several grounds. It denies the principle that organizational “form follows function”. It ignores the strong discipline of market competition upon corporate behaviour. And it is inconsistent with private enterprise. … If business were governed by boards that formally represented many social, economic, ethnic, or other interest groups in society, they would lose singularity of motive and competitive vitality. The corporation would change from a cost-conscious, profit-motivated entity into a political organ pursuing conflicting values… Such a board would be a debating society, incapable of reaching the timely decisions that are essential to efficiency.

Lord Wedderburn of Charlton"The Legal Development of Corporate Responsibility – For Whom Will Corporate Managers be Trustees?", Corporate Governance and Directors’ Liabilities – Legal, Economic and Sociological Analyses on Corporate Social Responsibility

Introduction: Berle-Dodd debate is still the central modern problem of corporate responsibility (Berle says corporate powers in trust for shareholders; while Dodd says these power were held in trust for entire community).

Most important for author’s purpose is the legacy bequeathed to modern company law by two contemporaneous events: the new managerial description of modern corps, originating with Berle and Means, and the new prescription that those in control pursue new goals because public opinion demands that corporation should serve a social service as well as profit.

Basis of British company law: fundamental model remains that of the shareholders “city state.” There is a balance of fiduciary duties and interests of the company (interests of present and future members of the company). The slow pace of change has been caused by the central tension which social and economic developments have implanted in the very system of company law and practice itself. British company law incorporates a central obligation of the directors to maximize benefits to shareholders.

Berle and Means – “Managerialism” and its critics: profit-maximization is denied by the prescriptive limb of managerialism, which sees the director at the point of convergence of a number of interests involving the operation of the firm: shareholders, employees, consumers, etc. The


director’s free hand is here freed from the dominance of profit so as to conjure hat a rabbit fit to feed all comers.

Some critics have argued that Berle-Means debate has undermined public confidence in capitalism’s arch institution, the large corp; and have asserted that any responsibility for managers others than to their stockholders is fundamentally subversive.

More moderate view holds that once idea of profit-maximization is abandoned, it is not easy to construct an attractive and logical new framework to guide management.

For some, the solution is simple: social responsibility of its business is to increase its profits. A reply might be that those who wield the power of the giant corp do indeed exercise all those social functions and often transnationally too.

There is not new consensus on a value system; no criteria to replace the standards which economists have developed over the last century. That is at the root in all responsibilities of directors and lines and duties and rights within the enterprise.

Social responsibility of the corporation – aspects of the US debate: two features o debate: its immense quantity and rich texture; and the virtual absence of certain themes found in UK and European debate.

CSR and profit-maximization: classical school in all countries is still profit-maximization, but is commonly thought that almost all embrace the notion of some social responsibility, but how much and when? Friedman supporters allow for elements of social responsibility to fit into profit-maximization as another social cost; while others suggest that in community service, philanthropic enterprise, etc. the corp’s acts would produce long-term benefits for stockholders.

Primary response of positive law was to remove major difficulties that might lie in path of management’s power to put into practice its recognition of social responsibility. The business judgment test has protected management in respect of most gifts so long as indirect benefit to the corp would somehow be envisaged.

The very place and importance of corps in our lives tells us that their dimensions have outgrown models such as city-state stockholders who control managing agents for profit subject only to rare signal to which obscure osmosis managers will respond.

“Managerialism” – some consequences in American law: developments in US business judgment principle seem to owe much to the concept of management as independent.

Where stockholding interests of investors are involved, one finds no uniform acceptance in the US of managerial independence bounded only by business judgment. In takeovers, for example, while the law accepts many managerial strategies to defeat a bid, the view is vigorously advanced by some that the decision must be left to shareholders of the target company unaffected by management who should remain passive. In Britain, directors of target companies have, if not a free hand, a very wide power to defend the company against a bid.

Legal avenues to CSR: legal solutions for CSR conundrum are not easy to find. Social responsibility campaigns of the 1960s and 1970s do not suggest that adjustments of stockholders’ legal powers could easily enforce new agreed norms of responsibility. Although shareholder social action (such as sing proxy regulations to stop production of napalm for human killing by Dow or the campaigns for ethical investment such as to stop Infant Formula in developing nations) may win a battle with new weapons, but could hardly win the war to transform CSR.

On the other hand, schemes for client group participation, with membership extended from stockholders to employees, suppliers, dealers, etc. raise the prospects of boards with multiple constituencies and perhaps even derivative actions by employees and customers, etc. In such a system, the risk would be that courts would be called upon to administer corporate policy by choosing between different versions of the reasonable balance of interests in practice.

Great ingenuity has now gone into proposals for remodelling the US corporate structure, such as voteless corps.


Some have called for more truly independent characters to be placed inside the board itself to monitor and change management. But experience with investment companies where this has occurred is not encouraging.

Perhaps the most idiosyncratic plan for reform of the board is that put forward by Stone. Since the problem of responsibility can only be solved by intrusion into the boardroom, largely because corps do not respond to external legal stimuli, every large corp should have a minority of members appointed by a federal agency, though they would be removable by unanimous vote.

His more modest proposal is for special public directors appointed by the court, for example, for violations of a continuing character, to promote more thoughtful conduct.

Most extensive plan for reform along the lines of constituency or client representation has come from Ralph Nader: all large corps should require not only a State but a Federal charter imposing a variety of employment, antitrust, and other social conditions. But Nader’s solution does not solve the critical question of multi-board constituency board and what guidelines will conduct the board to a decision on conflicting interests.

American debate and its European counterpart: impasse reached in the US debate about CSR related to three factors, which distinguish the US from Europe:1. First, each school advances a solution in order that the competitive enterprise system can be made

to work equitably and efficiently. In the US, government powers to appoint directors would require a major political struggle; while in France, where a power of government to ensure the contribution of the business to the national plan.

2. Second, the Western Europe line of thought whereby some system of public corporations is seen as an alternative to or development from a private competitive enterprise system has little place in the US debate.

3. Third, varied trade union movements in Europe are in origin and central traditions fundamentally different from the business labour unions of the US. Their membership and influence in the workforce generally higher than the US.

Corporate responsibility in Britain (social and legal evolution of responsibility): while Berle-Means debate was well-known, it was put to use in legal debates not about rearranging the constituencies in the corporate machinery, but about the consequences and possibility of their being replaced by controllers appointed by a Minister after nationalization.

By 1960, management certainly seemed to have achieved independent status in company law as evidenced by laws concerning gifts of company assets. The law ascribed an implied power to make donations whenever it would derive from them direct or indirect benefit.

Some gifts were eventually found to be ultra vires the company in one case and courts have subsequently made it clear that if a company’s memo included an express object to make any gift it chose to give, no ultra vires issues would arise. The complexities of the interactions between the doctrines of ultra vires, fiduciary duties, majority shareholders’ rights, etc. reveal the tensions of courts caught in a legal web of rules based upon shareholders’ democracy against which the social facts rebel. Judges are unwilling to adjudicate such questions in light of delicate questions of social policy and accountability.

Current legal problems: it is from the treatment of director as a trustee or quasi-trustee that the tensions of the UK system emerge.

Positive law in the courts: In handling of assets, the director is a constructive trustee; yet it is through personal fiduciary duty that trust was place upon directors.

It is a duty fraught with tension: the old equity notions of trusteelike duties are strict. US courts have building in a fairness element that is flexible. This is one way to resolve the problem, but it does so at great expense to the fiduciary principle.

The English fiduciary principle prohibits the director from making any secret profit from his office. The duty is strict, and yet it is trite law that directors can seek absolution of their sin by a mere ordinary resolution in a shareholders’ meeting. This approach may allow shareholders to approve even serious breaches of duty.


Despite its background of equity and trust, the British debate about company law has hardly appreciated the need for any public interest element in approaching majority and minority private corporate rights. In Britain, internal responsibilities in the corp require a framework of overall norms for corps in society, which appears attainable only by or through Parliament.

UK courts have suffered perplexity on the question of the control of corporate litigation. This has revived the question of whether management’s right to manage – currently resting rather quaintly on a pre-managerial consensual theory (in articles of association) – ought to be stated in statute. Although the public interest factor in the issue is obvious, but there is no route by which that can come into the courts’ considerations.

Uncertainties in the legislation: traditionally Parliament has clung to a system of shareholders’ control plus disclosure in order to ensure that management maintained unstated levels of behaviour which all gentlemen were expected to understand. By the 1960s, Parliament realized that mere disclosure by directors would not satisfy modern social standards.

After 40 years, resistance to legislation on insider dealing finally broke down and legislation was enacted.

Only in one area has legislature intervened with a definite pointer to social responsibility: it became fashionable to decry the legal definition of the interests of the company as limited to those of shareholders over the long term.

Attempts for UK courts to mould a new multi-dimensional concept of the interests of the company are likely to be still-born, especially when there is little realization that they will involve a new balance of private interests within a frame of public interests which are largely lacking from the debate, unless the public interest be confined to the profitability of companies.

Proposals for reform and the Companies Act 1980: companies did place non-legal duties upon themselves in ways that were said to be world-wide.

many schemes preferred to reorganize the private company along lines of various constituencies: to build on co-partnership or to make the company responsible to shareholders, workers, consumers, and the community.

The onslaught of the recession, however, stifled the industrial democracy debate. Shop stewards today show less desire to serve on company boards if its job is to plan redundancies.

National and transnational powers in trust: there is no absolute rule that legal reform of the enterprise must be abandoned in an economic recession. But the crisis in the world economic disorder makes contemplation of the dimension introduced by multinational or transational enterprise a horrific prospect. The issue of social interest is now raised to a power of international perplexity.

What is a good international citizen in transnational business? Various sources of international regulation – UN Centre and Commission on Transnational Corporations, International Labour Codes, etc. – have long been trying to find codes to which transnational enterprises will adhere. No doubt it would be desirable, though astonishing, if they could engender an international company law administered by a supranational body.

Another notorious difficulty is achieving even modestly effective international union and labour cooperation. Capital flows easily across frontiers; labour does not. International collective bargaining is also fraught with many difficulties.

The primary relevance of industrial democracy to CSR on the international plane may sometimes make dialogue between European and US counterparts more difficult. A system of labour law and antitrust law which insists that unions and management must relate not through combination but only through collective bargaining may make dialogue more difficult, though the appearance of a union leader on the Chrysler board has clearly stimulated positive thinking as well as understandable perplexity.

The overall participative factor of workpeople is a critical constituent in concepts of CSR that are likely to be viable in tomorrow’s world.

No solution for managerial authority can be found, none certainly that will stick nationally or internationally beyond the present crisis, without some renegotiation of the legitimacy on which


corporate government rests; and that cannot be accomplished without the acceptance of the workers as an integral constituent in the business corporation. Where the corporate group is transnational, that constituency too is multinational.

The problems of the national and multinational corporation are brought into the same focus. The need is for mechanisms, both internal to and external to the enterprise, through which wider social responsibility can emerge, procedures which will inevitably modify the objective of maximizing profit without attempting to replace it at a stroke by some other substantive formula. To this quest, both US and European debates have contributed.

If law can or should no longer assume that profit-maximization is the only touchstone of CSR, it is obliged to give to private capital some new guidance, nationally and internationally, on the price which it demands today for that very privilege.

Klaus J. Hopt and Gunther Teubner (1985) Walter de Gruyter, Berlin, New York, 3

Krause, Detlef "Corporate Social Responsibility: Interests and Goals", Corporate Governance and Directors’ Liabilities – Legal, Economic and Sociologial Analyses on Corporate Social Responsibility, edited by Klaus J. Hopt and Gunther Teubner, (1985) Walter de Gruyter, Berlin, New York, 95I. Social Responsibility: An inherent Characteristic of a Socially Responsive Societal SystemA. The Problem to be Solved Social responsibility (SR): the actor taking responsibility for the social impacts of his action How to operate this principle? Principle of SR operates effectively mainly by providing for principles and mechanisms of social

exchange, or, more generally, of social regulation or guidanceB. The Type of Problem-Solving Envisaged SR is a problem of principles and means, i.e. mechanisms and institutions required to build up and to

guide social interactions within a societyC. Responsiveness before Responsibility SR: associated with conscious personal engagement in social matters Social Accountability: characterized by a liability aspect Social responsiveness: suggests that constitutive and regulative arrangements are functional, and

conducive to securing socially responsible responses to social problems – inherent characteristic of any societal system

II. On Corporate Interests and Goals: Identifying Responsibilities for Responsibility GapsA. Rights, Interests, and Goals: Close Circles? The rationale underlying most proposals to make an enterprise more socially responsible is that there

is a connection between rights, interests and goals Creating and deepening social responsiveness as a necessary functional precondition for putting

social responsibility into practice requires the creation and specification of (property) rights to allow (individual) interests to be pursued to the fullest extent

Rights entitlements describe the opportunity set for actions Three types of entitlements: inalienable entitlements, entitlements protected by liability rules and

entitlements protected by property rules Publicly-held corporations: property rights are divided into control and income rights Who is to be held liable for violations?B. The Profit-Maximizing Proxy: Scope and Limits It’s widely held hat making profits (economically responsible) is quite the opposite of being socially

responsible


It is worthwhile to clarify the difference between profit as an end in itself and profit as a positively functional means toward social responsiveness and social responsibility and to examine more thoroughly the true nature of economic goals in relation to social goals

Challenging the profit goal itself would be the wrong strategy for increasing social responsibility. Such a strategy would decrease the degree of a societal system’s social responsiveness

In general, economic goals are social goals, in that hey are deeply rooted in human nature Social responsibility therefore refers to the same class of social affairs as does economic

responsibility What interaction is there between the interest of certain classes of interest-specific actors in the

satisfactions of their needs and the common needs? What is the relationship between the profit-goal and the pursuit of interests? Radically seen, the optimal means of upholding or of deepening social responsiveness consist of two

intertwined elements: the reforming of the bundle of property rights regarding participation in corporate affairs and the typing of interest mediation to profit-making

Introducing the figure of a corporate actor and ascribing to this corporate actor the job of profit-making is necessary but not sufficient for handling the problem of corporate responsiveness

In neoclassical model, any unreasonable profit-increasing deviation from the path of perfect competition is a loss of societal well-being: this includes internalizations of unreasonable gains, intentional lowering of product quality, wilful exacerbations of environmental loads

Survival (= economic success for corporations) is necessary for a purposeful social systemIII. How to Close the Gap Between Corporate and Societal GoalsA. The Problem Specified The implicit objective junction of the ideal of social responsibility is reducible to the first sub-goal of

economizing on the use of natural and human resources; and to the second sub-goal of enlarging the opportunities of individuals and social groups to get ever more equal chances for the realization of a satisfactory way of life

Rationale for creating and implementing compensations for the deficiencies and support for the desiderata of the perceived rules of the game: the way to make corporations more responsive to public needs is to make it economic for corporations to be so

B. Threatening Profits as the Basic Strategy The rules of the game within which business must operate are changing. If the social environment is

such that all firms are expected to make a social effort or assume “social responsibilities” then not to do so would adversely affect the present value of the firm: this perspective treats corporate social responsibility as an economic good

This might be do-able voluntarily: if the legitimacy of the corporation requires it, i.e. the socio-political climate is such that it is demanded, and performing “social audits” so the information is available

Voluntariness is desirable, but unrealistic as the sole mechanism Another approach: internalizing interests – would make corporation more socially responsive, but this

means self-threatening of profits and rewards in the present in order to preserve chances for profits and rewards in the future.

Internalizing internal interest: the real functional involvement of different persons and groups in corporate governance and decision-making justifies the adaptation of legally established (property) rights to the actual use of rights of participation. This is simple. But the main problem of allowing for internal interests in corporate affairs arises out of their external relationships

What about internalizing conflicting external interests? Any direct internal representation of external interests in general tends to coincide with a tendency to

make a corporation the self-service instrument of privileged interest groups (e.g. improving employment standards hurts consumers because the price increases), i.e. there’s a tradeoff

It is therefore appropriate to evaluate proposals for interest representation at the corporate level in terms of overall costs and benefits, and then have efficient interest settlement


IV. Conclusion The formula remains valid that profit-making reflects society’s goals with some accuracy and it

informs the corporations with relative accuracy and clarity of what society wants them to do Interest-based considerations could be very helpful in designing new bundles of property rights, rights

to participate in organizational affairs by the mere fact of organizational membership The most effective strategy for preserving corporate adherence to the rules of the game is to threaten

corporate profits, whether by consumer choices, moral public judgements, law-making and law-enforcement, or by public accusation of wrongdoings

External regulatory intentions should be made as compatible as possible with the inherent characteristic of purposeful organized social systems

Tichy, Noel M., McGill, Andrew R., St. Clair, Lynda Corporate Global Citizenship – Doing Business in the Public Eye, (1997) The New Lexington Press, San Francisco, 2

the level of corporate interest in pressing social problems in their communities is moving beyond traditional corporate philanthropy. Author’s bias is towards increased citizenship activity by corporations, especially those with global business activities or aspirations, because these organizations bear the burden of contributing to the social well-being of those communities where they do business the world over, not just in their traditional home bases

corporate global citizenship aims to enhance the quality of community life through active, participative, organized involvement. It is one of the many different types of activities that make up the broader concept of CSR.

corporate citizenship and social responsibility must not be viewed within the narrow context of a single community, or decisions that might benefit one community could be detrimental to the broader global community.

good corporate citizenship provides numerous benefits that are standard rationales for involvement: improved community and public relations, visibility, and reputation; better marketing; and an increased ability to attract high-quality people.

In many instances, corporations have more wealth at their command than the communities in which they operate. Because they operate in a multinational, global environment, corporations are accountable not to national governments but to their shareholders for most of their actions. Regulatory constraints notwithstanding, corporations face relatively few externally imposed limits on their activities. This combination of great wealth and broad discretion makes modern corporations enormously powerful.

traditionally, corporations have exempted themselves from social and environmental problems, focussing instead on performance and shareholder return. However, as it becomes apparent that the complex issues of today demand more than government intervention can accomplish or should attempt, businesses are rethinking their role as global citizens. Motivated by concern and enlightened self-interest, corporations are enlarging their definition of appropriate involvement and beginning to address environmental and human capital changes.

Global citizenship entails an understanding and awareness of future trends that will affect both the climate for doing business and the quality of life of the world’s population. As we move into the 21st century, global businesses will find themselves increasingly intertwined with global political , social, and environmental issues that will force them to redefine their role as a potent force for world integration. This force, coupled with the pressure being exerted by a burgeoning world population, is determining the need for global citizenship.

a corporate global citizenship approach to such challenges encompasses 5 cornerstones:o understanding – corporate global citizenship starts with understanding social issues,

cultural differences, environmental problems, and ecological issues.o values – it means having values that optimize the potential of human capital and preserve


the world’s environmento commitment – it takes commitment, caring about the values, and making long-term

investments o actions – it encourages action that institutionalizes the values and commitments within

the company and rewards employees on that basiso cooperation – it is above all a cooperative approach between people, community, and

government there are a variety of perspectives on what a company must do to be a good corporate citizen.

Conservative economists like Milton Friedman think that all you have to do is meet the fiduciary obligations to shareholders, as the market is best suited to solving social problems. A less conservative viewpoint is that taking some degree of responsibility for social involvement is good for the long term interests of the corporation; others think that in the end, corporations can’t do that much anyways so should not get involved. In practice, it must be a combination of altruistic and pragmatic reasons.

Fombrun, Charles J. "Tree Pillars of Corporate Citizenship – Ethics, Social Benefit, Profitability", Corporate Global Citizenship – Doing Business in the Public Eye, Tichy, Noel M., McGill, Andrew R., St. Clair, Lynda (1997) The New Lexington Press, San Francisco, 27

The crusade: if individuals and corps have almost equivalent legal and political standing, should we not demand of them equivalent moral standing?

By corporate global citizenship, the author means the responsibilities that attach to a corp by virtue of its membership in society. He uses the term citizenship to crystallize a corporate mindset that is slowly taking root in companies throughout the world and especially in the US. There is a movement to recognize that companies are not only engines of economic growth but also pivotal agents of social and political integration.

Traditional exhortations that companies should behave responsibly have failed because they have relied principally on ethical reasoning to defend corporate citizenship without sufficiently accenting the desirable social and economic consequences of citizenship.

Against the moral concept of responsibility and the political concept of citizenship, two others are juxtaposed: social concept of integration and economic concept of reputation.

Corporate citizenship is justified by a fusion of moral and teleological reasoning that champions ethical behaviour, social integration, and long-run profitability.

A commitment to corporate citizenship defines not only a moral basis for management practices but also a dedication to creating stronger ties between people and the larger communities to which they belong. Trend toward company-supported volunteerism, community networking, employee participation, etc. These are practical means that path-breaking companies are taking to reduce employee alienation, achieve social integration, improve reputation, etc.

Rationale for corporate citizenship is based on three core arguments: first, corporate citizenship is ethical; second, corporate citizenship is socially beneficial; third, corporate citizenship is profitable.

Why corporate citizenship: public activists have become more vocal about environmental damage. Beyond asking companies to pay economic penalties, there is also a clear expectation that they demonstrate responsible citizenship in society. For them, citizenship means favouring sustainable business activities.

Heightened global interdependence has also prompted convergence around shared values. The UN’s Declaration reflects this. By specifying work standards, equal pay, clean environment, the charter conveys values that define a company’s responsibilities in the global community.

Some private groups have also formed that advocate practices consistent with corporate citizenship. By granting high-profile awards and publicizing ratings of comparable firms, pressure groups,


advisory firms, and investment funds call attention to the merits of activities and programs that better integrate employees and companies into communities, etc.

The good citizen: corporate global citizenship can be assessed from different perspectives. Author proposes a three-part view of citizenship as: (a) a reflection of shared moral and ethical principles; (b) a vehicle for integrating individuals into the communities in which they work; and (c) a form of enlightened self-interest that balances all stakeholders’ claims and enhances a company’s long-term value.

Companies whose actions demonstrate citizenship will build valuable reputational capital that becomes a source of competitive advantage.

The concept of corporate global citizenship rest on three pillars of social responsibility, community integration, and reputation building.

The moral pillar - doing the right thing: a moral approach to corporate citizenship tries to articulate sacred and symmetrical duties and obligations that all companies have as institutions. It suggests that managers and companies should act in particular ways because it is the right thing to do.

Under capitalism, many laws governing competition derive from moral reasoning (e.g. cartels, collusive agreements, etc. are immoral because they reduce the welfare of the system).

A principled approach may fail because companies operate in a fragmented world of multiple cultures, each of which condones different behaviours, which can lead to a type of cultural relativism (e.g. paying bribes to officials in certain countries).

The weakness of this approach to corporate citizenship can also be traced to internal corporate diversity and weak control systems.

Author suggests that moral principles alone constitute a relatively fragile defence for encouraging social responsibility. Thus, argument for corporate citizenship should be buttressed by two other pillars: social integration and long-term sustainability of the business enterprise.

The social pillar – community integration: social pillar recognizes businesses as key players in building active, responsive communities. Underlying justification for corporate involvement in community activities is the sense that so many of our daily activities are governed by companies in which we work.

A key aspect of corporate global citizenship involves the protection of individual rights as well as the community. It means encouraging and sustaining full participation in the social and cultural life of local communities. Giving financial support is only one aspect; it should also involve volunteerism and transferring of skills from corporate sector to non-profit, education, cultural and other community-based groups.

The economic pillar – long-term sustenance: the core idea is that citizenship practices, because they build reputational assets, stimulate long-term profitability and build economic value worthy of capitalization on the asset side of a company’s balance sheet.

A citizenship outlook is consistent with stakeholder models that expect managers to balance the interests of all groups affect by the actions and decisions of a company. Many of the interests are incompatible in the short run; only with a long-run view can these divergent interests be accommodated.

The vital link is reputation: reputational capital is built up from the quality and kind of repeated experiences a company has had with its stakeholders.

The long-term viability of a company requires fulfilling expectations of all stakeholder groups. This translates into greater stakeholder commitment to the company, and profitability. Thus, corporate global citizenship constitutes enlightened self-interest.

Formal definition of corporate global citizenship: it is a mindset according to which managers: (a) make corporate decisions, design systems, and initiate programs according to prevailing moral principles; (b) encourage community-wide integration; and (c) build reputational capital wherever in the world they conduct business.

Enlightened self-interest: management training programs and business schools taught an undersocialized view of capitalism that championed the shareholder over other stakeholders; that


stressed the bottom line at all costs; that scorned those who were concerned with more than the financial implications of corporate decisions.

Today we pay the piper as we tally the record of wrong-doing, infractions, white-collar crime, all of which can be traced to a loosening of attention to moral standards, social control, and reputational integrity.

Rebuilding the community will require greater commitment and effort from both the government and the people.

Communitarianism – morality as a community affair: a group of ethicists and social philosophers met in Washington in 1990 to explore the problems that afflict our society. They adopted the name communitarianism to emphasize our responsibilities to the conditions we all share to the community. Community is the mainspring of our values.

Nongeographic communities, which are made up of people who do not live near each one another, may not have foundations as stable and deep-rooted as residential communities, but they fulfill many of the social and moral functions of traditional communities. Work-based and professional relationships and community groups.

Although some critics attack have attacked these communities as artificial, they tend to have the moral infrastructure we consider essential for a civil and humane society.

The role for corporations in the nineties: many businesspeople no longer accept the responsibility of stewardship; they no longer see it as their duty to reach beyond furthering their self-interest to serve as trustees of a social undertaking.

Although some markets work best if everybody tries t maximize his or her own self-interest, moral behaviour and communities do not.

People are better off when they combine their self-advancement with investment in their community. There is a need for corps to become not only more family-friendly but also more community-friendly.

The limits of corporate Puritanism: critics of the morality evoke the spectre of neopuritanism by pointing to corps that use their economic power to force their employees to behave. Businesses, they say, are insisting that their employees refrain from smoking, drug abuse, etc. The courts have already ruled that corps may not impose conditions of employment that are unconstitutional.

Should corps attempt to regulate this behaviour? Probably not. In short, when private behaviour directly affects job performance, corps may step in, otherwise, they should not.

The communitarian family and what companies can do to support it: parents have a moral responsibility to the community to invest themselves in the proper upbringing of their children. Children require time and attention, and thus, we must dedicate more of ourselves to our children’s care and education. We need to return to a situation in which committed parenting is an honourable vocation.

From citizenship to sustainability: achieving sustainability will require stabilizing or reducing the environmental burden. This can be done by changing the technology used to create the goods and services that constitute the world’s wealth. Although population and consumption may be societal issues, technology is the business of business.

As of today, few companies have incorporated sustainability into their strategic thinking. Focusing on sustainability requires putting business strategies to a new test. Taking the entire planet as the context in which they do business, companies must ask whether they are part of the solution to social and environmental problems or part of the problem. Only when a company thinks in these terms can it begin to develop of a vision of sustainability.

March 31, Class 25: Can the state remain the regulatory foundation of corporate social responsibility?These readings discuss how corporations might be regulated to prod them toward social responsibility. Note that these readings are now in various respects dated, which may reveal emerging institutional incapacity of the state in the wake of globalized markets.


Graham, Cosmo "Regulating the Company", Capitalism, Culture, and Economic Regulation, ed. by Leigh Hancher and Michael Moran, (1989) Clarendon Press, Oxford, 199 The inspiration for this chapter was dissatisfaction with the narrow view of company law in Britain Just examining the legal rules governing the relationship between shareholders and directors is a 19th

century view of the company which fails to recognize that internal organisation of companies is a matter of public concern/interest

It is argued that it is necessary to look for new legal and organizational forms which can cope with the complexities of modern society

This chapter interprets all theories as answers to the question: why should a group of persons receive special privileges from the state, notably limited liability?

The Classical Model Economy composed of numerous private firms, of more or less equal power who competed amongst

each other for customers The legitimating element was that no one firm could dominate the market Internal organization of companies: dominant theory was the contractual model (between

shareholders and directors) The role of law was limited, and consisted of ensuring the terms of the contract were followed, and

the imposition of fiduciary duties Laissez-faire state: enacts only general, formal-rational law, pursues fraud and set the ground rules for

competition in the market Corporations are private This model became increasingly unreal in the 20th century: growth of large firms meant market not

always competitive; effective breakdown of shareholder monitoring (divorce of ownership and control)

The Pluralist Model Debate between Berle and Dodd on power of corporate managers: Berle – separation of ownership and control raises problem of legitimacy, because managers are

invested with power and lacked any effective oversight. The modern corporations’ increasing economic importance obliged them to take on wider functions than merely profit-making

Pluralistic model is pluralistic in two ways: (1)it is a theory of the state and the role groups play within it; (2) it is a set of ideas about corporate governance

The social system is a balance of power among overlapping groups, each of whom are constrained through the process of mutual group and adjustment and all of whom share a broad value consensus

If the modern corporation is a quasi-public entity, it is legitimate to take into account a range of interest wider than those of shareholders

Regulating corporate activities directly encounters the problems of information deficits and agency capture, so the way forward is to reform the corporate decision-making process to make it more “responsible”

Could appoint public directors to corporation (proposal of Nader and Stone)Industrial Democracy Largely a European debate Starting point: the problems faced by the pluralist model: the changing economic nature of the

corporation and the breakdown of the traditional model of the company But this model envisages a more activist conception of the state and greater power of trade unions

than does the pluralist model Key point: give workers a place on the board (a la Germany) I argue that both pluralism and industrial democracy are imperfect. But if, as the corporation is quasi-

public, a wider group of interests than simply those of shareholders should be taken into account, how to design institutions which will allow this?

The Neo-Classical School


The neo-classical model disputes the premise that the conditions of the classical model have broken down and therefore the justifications for giving companies special privileges has become problematic

Corporate power is restrained by market mechanisms, and trying to replace market constraints is impossible

Corporations must maximize profits because if they don’t they’ll be taken over or they’ll go bankrupt; also profit maximization offers the only legitimate guide to corporate action, as corporate social responsibility (CSR) simply allows a corporate manager to spend other persons’ money in a way they would not have wished

we should put our faith in market mechanisms (product market, market for corporate control, market for managerial services)

The main different between this model and the classical model is the monitoring role played by shareholders in the classical model is superseded by almost entire reliance on the market mechanism

Resumé The dispute between the pluralists and the neo-classicists cannot be settled in the space of this

chapter, but here are some comments There is a body of literature taking issue with the assumptions of neo-classical economics Once the goal of a corporation becomes long-term profit maximization, it has been argued that it

becomes very unclear whether certain corporate actions are profit-maximizing or socially responsible An efficient corporation will plan for uncertainty. Any planning process demands proper information

and alternative ideas and strategies. Then why not institutionalize the voice of those actors who are affected by the corporation’s actions?

Can’t just assume the market is free, spontaneous growth: the ground rules are set by the StateThe German Experience Two-tiered board structure composed of a board of management and a supervisory board The board of management is appointed by the supervisory board, and has a duty to disclose

information to the supervisory board The supervisory board performs general oversight, and is chosen by the shareholders Certain matters are reserved for the shareholders by law and the company’s constitution. But the

shareholder, in exercising these rights, must take into account the interest of the company Co-determination: supervisory board system provides for employee representation on the boardCurrent British Trends The core notion of the classical model is majority rules, with the majority taking their own interests

into account; but some changes: Insolvency law report: insolvency not just between debtor and creditor, and limited liability is a

privilege granted by the state which may be forfeited in certain circumstances: wrongful trading (not just fraud, but irresponsibility too) and disqualification of directors

There is a grudging and highly qualified recognition in caselaw and statutes that interest of creditors and employees should be taken into account as well as those of shareholders

Growing interest in Employee Share Ownership Plans (ESOPs): if employees base a large amount of their investment in one firm, they may become more risk-averse than capitalist entrepreneurs, and thus more likely to demand a share in the firm’s decision-making process

These trends suggest that the classical model is being abandoned. But if it is indeed abandoned, what is to be the replacement? The only two modern strategies are neo-classical model, and pluralist.

Hamilton, Walton The Politics of Industry, (1957) Alfred A. Knopf, New York, 136

This article is very general and doesn’t seem terribly related. I think the only point of making us read it is the fact that the issue of how to regulate corporations/ whether they should CSR was already considered difficult in 1957.

the problem is to make sure that the corporation through the best possible series of compromises, will


adequately serve all of the interests dependent upon it… To this problem a number of solutions basically different in character have been proposed. The list includes, though it is not limited to, the way of conscience, the use of competition, the rule of regulation, the merger of the business economy into the state, and a corporate political order in which all parties in interest are properly represented.

as long ago as the book of Judges it was recognized that to allow each to do that which is right in his own eyes would only lead to anarchy. So too for corporations: In the law as well as in common sense, it is anathema that, when two interests are in conflict, one party is to be allowed to resolve the dispute. In the affairs of the corporation, the principle that no man is to try his own case has not as yet been completely established.

The fading separation of state and economy has brought to the front a conflict of interest. In its operation the government requires the technical knowledge which corporate officials are believed to possess. Accordingly, it is the practice, in peace as well as in war, to bring business men into government for limited times. But they are not acquainted with the operation of public service, which produces a conflict of interest – all the more dangerous because it is wholly unconscious. The difficulty lies not in a consciously recognized interest but in values, habits, attitudes, folkways, which inhere in their very personalities.

a resort to judicial process is an essential of a system of justice. But an attempt to amend or revise the structure and practices of an industry by resort to judicial process is a task fraught with uncertainty. The legal process was intended to do justice in the instant case, to end conflict between two belligerent individuals. It as never shaped for so stupendous and alien a task as causing the channels of commerce to run straight, or fitting an industry out with a new and different set of practices.

one of the biggest problems with regulation is that business and government proceed at different speeds. In theory, the statutes demand that the agencies be policy-making bodies accommodating the mandates of the Congress to the changing circumstances of the industry. In fact, the agencies have come to limit themselves to questions which cannot be escaped, such as entrance into the trade, the provision of service and the level of rates.

must pick capitalism over communism. bad communism. an economy takes its character from the context of the culture in which it is set. against the beat and

time of circumstance, no country – whether Russia or the US – can preserve inviolate its distinctive industrial arrangements. And if groups of folk as distinct as those of Egypt, China, India, JPN, and Malaya should all go in for collectivism, the impact of all that the pat has wrought would presently cause them to go their divergent ways.

Berle, Adolf A. Jr. The 20th Century Capitalist Revolution, (1954) Harcourt, Brace and Company, New York, 61

Gives history of “Haro” cry that has long been known in Norman law and recognized as a means of appeal to the conscience of feudal power. It is probably one of the origins of the British law of equity. Even in Normandy, it became the basis of a special jurisdiction (there emerged Norman judges of “Haro,” competent to give extraordinary relief similar to equity courts).

The sovereign and his lords had power, but besides power, there were conceptions of right, morality, and justice. It seems a far cry from Norman dukes to corporation management, but the phenomenon of power is enduring and the distances is not so great.

Around its use the law authorizes a mantle of sanctity, the legal presumption that management action is taken for the best interests of the corporate institution. Behind this presumption lies great persuasion of fact.

Within a wide range, management power is absolute, but it could hardly be otherwise: if every decision were reviewable, the reviewing authority would be substituting its business judgment for that of management.

If anything is settled it is that the exercise of power is lonely business: within that range, the true judge is the conscience of the man or men who act.


If authority to act is ever resigned or referred to other, the institution breaks down (e.g. King Lear: king courts disaster by proposing to transfer his power – the one way ticket to tragedy).

Accurately analyzed, power is always absolute. It may be and usually is limited in scope. There is a limitation of the field of power; within those limitations is an enormous field in which management acts in its discretion, which is merely a lawyer’s way of saying that the power is uncontrolled. Yet is there no counterpoise to this sort of power?

Apparently absolute power in an organization is commonly accompanied by the emergence of countervailing power elsewhere in the same organization; and the two nuclei of power coexist in opposition to form a balance.

If ever authority was absolute and power unlimited save by physical capacity, it existed in England under the early Norman kings. The only real limitation was successful revolt.

Yet from the beginning, there was recognition of something intangible demanding to be taken into account. The king was supposed to redress grievance according to his best conscience. The conscience of the king had a wide field of responsibility.

Deep in human consciousness is embedded the assumption of a higher law that impose itself on princes and powers and institutions. Failure to satisfy the higher power could weaken materially or even destroy the effective power of the king.

It is suggested that a somewhat similar phenomenon is slowly looming up in he corporate field through the mists: a realization of a counter force, which checks and may modify certain areas the absolute power of business discretion. In our system it emerges as law.

[AH: The article ends with two long stories that I didn’t think were relevant for exam purposes!]

April 5, Class 25: Conclusion: Can corporate law be just?Any inquiry into the law must be tied back to an inquiry into justice. The course concludes with some reflections on justice in corporate law.

Green, Ronald M. "Responsibility and the Virtual Corporation", Is the Good Corporation Dead? Social Responsibility in a Global Economy, edited by John W. Houck and Oliver F. Williams, Rowman & Littlefield Publishers, Inc., 37 In 1978 Vagelos, head of research of Merck, received a memo from a senior researcher in

parasitology, Campbell that Campbell has a hypothesis that a new Merck antiparasitic veterinary compound might be developed for human use as an effective treatment for river blindness, a disease that plagued million in the third world.

Vagelos had to decide whether and to what extent he would urge Merck to commit itself to this effort. It would cost millions in research to learn whether Campbell’s hypothesis had merit If successful, there was little likelihood that this effort would prove profitable What can the field of business ethics bring to an executive as he ponders this type of decision? At

least two basic views: Classical view (Milton Friedman): the social responsibility of business is to increase its profits. CSR

is an unconsented diversion of shareholders’ resources to purposes not their own, and corporate managers lack the expertise or competence to address social needs or problems beyond their business sphere. SCR only justified if it is in the long-run interest of a corporation to do the act (e.g. if it will majorly increase goodwill)

CSR: business firms and, by extension, business managers have an affirmative moral obligation beyond their duties to shareholders and their legally mandated duties to other corporate stakeholders to improve the social environment.

Justifications of CSR: recognition of corporations as legal persons (i.e .benefit state gives them) implies a corresponding set of obligations to demonstrate good citizenship and social usefulness; the


mere fact of corporate power implies the need for responsibility; corporate managers are often those with the greatest expertise in solving social problems

Both classical and CSR that there is a tension between a corporation’s economic and moral objectives. The disagreement is over whether managers may morally authorize the payment of this price

I will now put forward the perspective disagrees with this tension. The “business excellence” perspective holds that a corporation’s commitment to the needs an welfare of all its stakeholders provides the essential underpinning of economic success

In today’s complex world of advancing technology and constant innovations in products and services, competitive advantage increasingly lies with those companies that can stay closest to the needs of their customers, clients, and other key stakeholders

In some areas, like pharmaceuticals, high technology firms necessarily work in the complex new environment of government-university-industry technology transfer

Customers are increasingly involved directly in corporate decision-making Environment of teamwork, where employees, management, customers, suppliers, and governments

all work together Within this environment, corporate ethics is not just a matter of avoiding wrongdoing, nor is it merely

a philanthropic afterthought to the primary process of pursing profit. Instead, it is an essential component in the pursuit of business success

Merck decided to develop the drug: recognition that its success is a function of the dedication of its educated staff of managers and employees (didn’t want to demoralize the researchers)

It is naïve to say that companies can concentrate on maximizing profit and ignore endeavors that engage the moral imagination of key stakeholders

Merck’s commitment to the welfare of its larger community of stakeholders is not reducible to a quid pro quo level of business calculation. It is primarily an ethical commitment, but one that has often benefited the company

This is the business excellence stance. If focuses single-mindedly on decisions that foster trust, cooperation, and value for both a business and its key stakeholders, whether these decisions are merely the fulfillment of expected daily ethical obligations or, the occasionally extraordinary effort to assemble corporate expertise and resources for the accomplishment of social goals.

This represents a real paradigm shift. It asks us to turn away from the endless debates over whether there can be too little or too much ethics in business, ot the recognition that modern business is all about ethics.

Eells, Richard The Meaning of Modern Business – An Introduction to the Philosophy of Large Corporate Enterprise, Columbia University Press, New York and London, 307

a corporate model for comprehending the actual role of business corporations in the society of today and tomorrow needs to take into account the pervasive governmental process. Before one can construct such a model, one must see the corporation in its more immediately relevant role as a participant in the whole economic process, as well as in relation to the wider social and cultural functions of a free society

the requirements of a viable model are that it state a corporation’s goals realistically… there are certain normative requirements, i.e. that the model should not be at odds with our preferred values.

there has been a great increase in the size, number, and power of large organizations of many kinds during the past century (called the organizational revolution) which was a response to the universal demand for better instruments in men’s hands to improve their economic conditions, implemented by greatly improved organizational skills and techniques.

19th C liberalism, with its insistence on laissez-faire and noninterventionism of every kind, gave way before a universal but uncoordinated movement toward organized intervention in the economic


process… Organizational control of the economic process is in some form inevitable, but can we keep the role of the state below ‘the critical level where the tyrant and his bureaucracy take over’?

the management of the economic process in a free society has thus become a problem of organizational method, and the problem requires us to makes choices, not between no-control and control, but rather between completely statized and other forms of organized control

the corporation is essentially a hierarchical system. While it is sometimes contended that in a free society there is no place for hierarchical organizations, this position is obviously untenable. Public government itself, even on democratic principles cannot dispense with hierarchically constructed bureaucrac in the administrative branches, civil or military.

the courageous assertion of corporate self-interest –which none can deny is a legitimate stance in a free society – has also to be coupled with the common search for formulas that will keep us all this side of the danger zone beyond with organizational economy swallows up personal liberty.

the corporation as a system of private government is relatively free – up to a point – to determine its own system of governance. The traditional corporate polity is said to be of necessity, if not a “self-perpetuating oligarchy” at least a system of private government that is non-democratic in theory and practice

the extension of federal constitutional law to corporations would require a whole new corpus of juridical interpretation, and an entirely new corpus of constitutional law would have to be developed

in a free society, a corporation, like any other legitimate organization, should be expected to exert its influence in the political arena as well as the market place. Its views about the ‘public interest’ are neither more nor less worthy of attention in the political area than those of any other group.

in sum, coordinate political functions of a corporation are needed because we live in a pluralistic society characterized by numerous decision centres, all of which must somehow act in concord to carry on the governmental process of a free society.


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