Margaret Blair & Lynn Stout - 1999

A TEAM PRODUCTION THEORY OF

CORPORATE LAW

Explanation of public corporation ownership Shareholders (principal) own corporation and hire offi cers

(agents) Goal of corporation is to increase shareholder wealth Corporation law is used to reduce “agency costs” and

maintain faithfulness of directors/offi cers (agents) to the principals

E. Fama, Agency Problems and the Theory of the Firm (1980) Advocated the separation of ‘management’ and ‘risk

bearing’ roles Used insights provided by Alchian and Demsetz (1972) to

establish agent and principal roles

PRINCIPAL-AGENT MODEL

Published in 1972 in AER Armen A. Alchian (University of California, Los Angeles) Harold Demsetz (University of California, Los Angeles)

What makes a team? The use of several resource types The product does not equal a sum of individual

contributions Not all resources used by the team belong to one person

Think about two people lifting a 100lb box Does each person lift 50lbs? Does one lift 75lb and the other 25lb?

PRODUCTION, INFORMATION COSTS, AND ECONOMIC

ORGANIZATION

Shirking: A problem with the a team Fixed by using a “Monitor”

Residual claimant Observe input behavior Central party common to all contracts Ability to alter team membership Ability to sell these rights (ownership)

When does a team become a fi rm? When it is possible to increase production through a team When it is economical to estimate marginal productivity via

observation

PRODUCTION, INFORMATION COSTS, AND ECONOMIC

ORGANIZATION

Blair and Stout (1999) refute application of Principal-Agent Model and corollary that corporations’ primary goal is to maximize shareholder wealth Model applies to firms in general, but provides no special

insights into public corporations

Team Production Approach Where a productive activity requires the combined

investment and coordinated effort of two or more individuals or groups

Issues occur in form of ex ante (agreement) shirking and ex post (agreement) opportunism

A TEAM PRODUCTION THEORY OF

CORPORATE LAW

Issues occurring under Team Production Approach circumvented by corporate law as a “Mediating Hierarchy”

Formation of Public Corporation provides a hierarchy existing outside original production team All team members “agree to give up control rights over the output

from the enterprise and over their firm-specific inputs” (i.e. to a BoD)

No single team member is a “principal” having right of control

Solves three primary issues with Team Production Approach: Convoluted information-gathering and decision-making Shirking and opportunism via principal-agent contracts Disputes between team members regarding allocation of duties

and rewards

A TEAM PRODUCTION THEORY OF

CORPORATE LAW

A public corporation is not simply a “bundle of assets” under common ownership, but rather a complex collection of agreements between team members working together for mutual gain: “A nexus of fi rm-specific investments.”

Control over assets and outputs are mutually given up in order to reduce shirking and rent-hoarding via implementation of an internal mediating hierarchy

A TEAM PRODUCTION THEORY OFCORPORATE LAW

A TEAM PRODUCTION THEORY OF

CORPORATE LAW

Infl uences of Corporate Law and Culture

Directors motived to do well if they want to maintain their positions Directors also motivated by desire to maintain reputations

Corporate law limits ability of directors to serve their own interests Directors unable to appropriate corporate assets beyond

established compensation Assumption exists that if directors cannot serve their own interests,

they will serve the interests of their firm (Is this a valid assumption?)

Corporate culture motivates directors to serve as fair trustees of firm Serves role of benevolent/trusted mediator implied in all contract

theory

KEEPING DIRECTORS FAITHFUL

May only be a “second-best” solution to relegation of asset and fi rm output control Given certain constrains, a board of directors may offer

substantial reduction in ineffi ciencies and rent loss

Mediating Hierarchy Theory expands on legal view of corporation as a “nexus of contracts” (explicit and implicit) Highlights importance of team production dynamics within

public firms Establishes tools to understand political nature of a

corporation Explains role of BoD in determining firm focus on

employees/shareholders

MEDIATING HIERARCHY THEORY