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Conservative & Libertarian Legal Scholarship: Corporate Law

X. Corporate Law
March 08, 1996

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X. Corporate Law 

Foundational Materials

Foundations of Corporate Law (Roberta Romano, ed., 1993), and Economics of Corporate Law and Securities Regulation (Richard A. Posner & Kenneth E. Scott, eds., 1980). These are useful collections of readings. For an overview of the law and economics literature on corporate law and finance, consult Chapters 14 and 15 of Richard Posner, Economic Analysis of Law.

William A. Klein & John L. Coffee, Jr., Business Organization and Finance (6th ed., 1996) is a very good reference book for students-particularly those with little or no exposure to business concepts.

Frank Easterbrook & Daniel Fischel, The Economic Structure of Corporate Law (1991). This is the most comprehensive application of the "contractual" understanding of corporations and other business organizations available. It includes chapters on the corporation as a nexus of contracts, limited liability, shareholder voting, fiduciary duties, corporate control transactions, the appraisal remedy, tender offers, antitakeover statutes, close corporations, insider trading, mandatory disclosure under the securities law, and securities litigation.

Paul H. Rubin, Managing Business Transactions: Controlling the Cost of Coordinating, Communicating, and Decision-Making (1990). A very useful intertwining of legal and economic/business concepts, as applied to real-world business problems such as the "make or buy" decision, employment and franchise contracts, and the promotion and protection of a business firm's reputation. Professor Rubin, an economist, suggests that, "for a lawyer, the book will help him understand what his business clients want to accomplish when they specify certain goals in their contracts."

The Contractual Theory of the Corporation

Henry N. Butler, The Contractual Theory of the Corporation, 11 Geo. Mason U. L. Rev. 99 (Summer 1989). This is the best short introduction and overview of the contractual theory of the corporation, which "views the corporation as founded in private contract, where the role of the state is limited to enforcing contracts." As Professor Butler explains, this view "is in stark contrast to the legal concept of the corporation as an entity created by the state. The entity theory supports state intervention [in the corporation's affairs] . . . on the ground that the state created the corporation by granting it a charter." This article also provides a survey of the major contributions to the contractual theory.

Frank H. Easterbrook & Daniel R. Fischel, The Corporate Contract, 89 Colum. L. Rev. 1416 (1989). Another good statement of the contractual view of the corporation, this article is drawn from a symposium on Contractual Freedom in Corporate Law, and appears in slightly altered form as chapter 1 of the Easterbrook and Fischel treatise noted just above.

Henry N. Butler & Larry E. Ribstein, Opting Out of Fiduciary Duties: A Response to the Anti-Contractarians, 65 Wash. L. Rev. 1 (1990). A stiff rejoinder to certain critics of the contractual view.

Bernard Black, Is Corporate Law Trivial?: A Political and Economic Analysis, 84 Nw. U. L. Rev. 542 (1990). Carrying the contractual view of the corporation to its logical end, Black concludes that the answer to the question posed by his title is, essentially, "Yes."

Robert B. Thompson, The Law's Limits on Contracts in a Corporation, 15 J. Corp. L. 377 (1990). While Thompson does not display an ideological opposition to the contractual view of corporations, he does argue that there are some areas of corporate law that remain mandatory-and rightly so. He also discusses differences between publicly held and closely held corporations with respect to the need for mandatory rules.

The Role of Fiduciary Duty

Robert Cooter & Bradley J. Freedman, The Fiduciary Relationship: Its Economic Character and Legal Consequences, 66 N.Y.U. L. Rev. 1045 (1991). The concept of fiduciary duties lies at the heart of much corporate and partnership law. This is a useful exposition of the concept, using economic analysis.

Douglas G. Baird & M. Todd Henderson, Other People's Money, 60 Stan. L. Rev. 1309 (2008). An argument that directors' duties are too narrowly conceived in corporate law since they are based on an outdated notion  of capital structure that prioritizes the interests of equity-holders over debt-holders and other corporate interests.

Shareholder Control and Shareholder Litigation

Stephen M. Bainbridge, The Case for Limited Shareholder Voting Rights, 53 UCLA L. Rev. 601 (2006).  A forceful argument that the U.S. economy outperforms its global peers not in spite of the separation of ownership and control, but because of that separation.  Prof. Bainbridge suggests that further reforms to the corporate system should be incremental, rather than radical shifts from the traditional system of corporate governance that separates ownership from control.

Roberta Romano, The Shareholder Suit: Litigation without Foundation?, 7 J. L. Econ. & Organization 55 (1991). Professor Romano's study of 139 shareholder suits filed from the late 1960s through 1987 leads her to conclude that "shareholder litigation is a weak, if not ineffective, instrument of corporate governance."

Lucian Arye Bebchuk, The Case for Increasing Shareholder Power, 118 Harv. L. Rev. 833 (2005). A forceful argument to reconsider the allocation of power between management and shareholders.  Prof. Bebchuk argues for allowing greater shareholder power in certain rules-of-the-game decision scenarios that affect management, which traditionally have been decided by management.  In Response to Increasing Shareholder Power: Director Primacy and Shareholder Disempowerment, 119 Harv. L. Rev. 833 (2005), Stepehn Bainbridge takes issue with Bebchuk's thesis, arguing that that the market for corporate securities takes into account corporate governance structures, and those firms with ineffective governance will see the price of their securities fall and that, while corporate shareholders are "rationally apathetic," their apathy is cured by director primacy.

Federalism and Corporate Law

Roberta Romano, The Genius of American Corporate Law (1993). The "genius" of the title inheres in the federal structure of American corporate law: each state can offer the privilege of incorporation to all comers. Because corporations are free to choose to incorporate (or reincorporate) in any one of the fifty states, the states compete for incorporation "business" and the contours of corporation law are defined by this competition. As a result, corporate law in America is said to be "enabling" rather than regulatory. If, as reformers have urged for years, a national incorporation statute were passed, consumers and investors would lose the benefits of this competition among the states and corporate law would likely become yet another regulatory code. Professor Romano's book is an important contribution to the current debate about our system of corporate law.

Ralph K. Winter, State Law, Shareholder Protection, and the Theory of the Corporation, 6 J. Legal Stud. 251 (1977). In this classic article, Judge (then-Professor) Winter argues forcefully against the "race to the bottom" view of interstate competition for corporate chartering, which holds that the result of interstate competition is a diminution in corporate law's solicitude for shareholder interests.  Prof. William Cary advanced the original "race to the bottom" argument that provoked Prof. Winter's response with his classic work on Delaware corporate governance.  Cary, Federalism and Corporate Law: Reflections Upon Delaware, 83 Yale L.J. 663 (1974).

Jonathan Macey & Geoffrey Miller, Toward an Interest-Group Theory of American Corporate Law, 65 Tex. L. Rev. 469 (1987). Develops an extensive model of Delaware corporate law formation to account for the fact of Delaware's long-standing dominance of the market for corporate charters. Concludes, among other things, that "Delaware law reflects a political equilibrium among the various interest groups within the state in which the lawyers enjoy a dominant position."

Mark J. Roe, Delaware's Competition 117 Harv. L. Rev. 588 (2003). An argument that the theoretical debate of race-to-the-top vs. race-to-the-bottom is misconceived since Delaware's primary competition comes from the federal government, not from other states.  Prof. Roe contends that when a corporate issue becomes too big, the federal government steps in (as in the case of Enron & Sarbanes-Oxley), so Delaware controls only that which the federal government allows it to control.

Mark J. Roe, A Political Theory of American Corporate Finance, 91 Colum. L. Rev. 10 (1991). Explores the connection between American populism and federal regulation of the securities markets and stock ownership. Argues that this connection best explains the differences between the American system on the one hand, and the German and Japanese systems, on the other. Roe's book on this subject, Strong Managers, Weak Owners: The Political Roots of American Corporate Finance (1994), is the subject of a lengthy review by Stephen M. Bainbridge, The Politics of Corporate Governance, 18 Harv. J.L. & Pub. Pol'y 671 (1995).

Todd Henderson, Beyond the Races: Re-examining the Relationship between Federalism and Corporate Governance, 77 Geo. Wash. L. Rev. 708 (2009). Henderson criticizes Robert Ahdieh's argument that corporate governance law is determined by markets not by state law, and therefore worries about a "race to the bottom" are misplaced. Henderson points out that while the market for corporate control disciplines managers, it is competition among states that disciplines states from distorting the market for corporate control. Part III of the article reframes the "race to the bottom" vs. "race to the top" debate by drawing on Thomas Sowell's A Conflict of Visions and concludes that the policy debate is really about a conflict of worldviews instead of the merits of corporate law. Henderson argues that scholars in the field of corporate law are not just reaching different conclusions; they are arguing on entirely different grounds. Henderson concludes by urging corporate law scholars to follow the lead of antitrust law by defining what a successful market for corporate law would look like, and then addressing the question of whether the market is working against that metric.   

The Involvement of Federal Regulation: Sarbanes-Oxley and Beyond

Richard Epstein, Is the U.S. Legal Regime Undermining U.S. Competitiveness:?  The Danger of Investor Protection in Securities Markets, 12 Tex. Rev. Law & Pol. 411 (2008). Epstein begins by noting four misconceptions of oversight of securities regulation. First, securities regulations, unlike other legal rules such as Statute of Frauds, lose their value over time and thus are subject to regulatory depreciation. Second, lawmakers too readily assume an inelastic private response to new regulations, and this leads to far more extensive systems of regulation than will prove in practice to be sustainable in the long term. Third, given the lack of constitutional protections against regulation or taxation, regulated entities anticipate new regulations in ways which lawmakers cannot predict. The fourth common mistake of regulators is to assume that the indirect consequences of regulation are small and can therefore be safely ignored. The indirect consequences of regulation are likely to undermine the efforts of regulators to confine the private responses to some narrow domain. Moving beyond the four misconceptions of regulators, Epstein highlights the unfortunate feedback loop between the level of judicial review in the post-Chevron era and the declining quality of regulations.  

For critiques of the Sarbanes-Oxley regime enacted in 2003 in response to the Enron scandal, see Stephen Bainbridge, Sarbanes-Oxley: Legislating in Haste, Repenting in Leisure, 2 Corp. Gov. L. Rev. 69 (2006); Jonathan Macey, A Pox on Both Your Houses: Enron, Sarbanes-Oxley and the Debate Concerning the Relative Efficiency of Mandatory Versus Enabling Rules, 81 Wash. U. L. Q. 329 (2003).

Mergers and Acquisitions

Henry Manne, Mergers and the Market for Corporate Control, 73 J. Pol. Econ. 110 (1965). A remarkably influential statement of the disciplining effects that the possibility of a hostile takeover can have on incumbent managers. Henry Manne, Our Two Corporation Systems: Law and Economics, 53 Va. L. Rev. 259 (1967). Another landmark study explaining the differences between the theory of classical corporation law and the realities of corporate life.

Roberta Romano, A Guide to Takeovers: Theory, Evidence, and Regulation, 9 Yale J. on Reg. 119 (1992). Surveys the huge literature on mergers and acquisitions. Since "[t]he empirical evidence is most consistent with value-maximizing, efficiency-based explanations of takeovers," Professor Romano argues that "much of the takeover regulatory apparatus [which seeks to "thwart and burden takeovers"] is misconceived and poor public policy."

Executive Compensation

Todd Henderson, Executive Compensation in Bankruptcy: Paying CEOs when Agency Costs are Low, 101 Nw. U.L. Rev. 1543 (2007). According to Professor Henderson's study of financially distressed firms, while the managerial power theory suggests that the increased monitoring typical in Chapter 11 cases should lead to lower levels or different types of compensation, or both, what happened instead was that no firm dramatically altered its compensation methods despite the reduction in agency costs.

Randall S. Thomas, Explaining the International CEO Pay Gap: Board Capture or Market Driven?, 57 Vand. L. Rev. 1171 (2004).  Professor Thomas' article offers five alternatives to the Board Capture Theory that justify higher pay for American CEOs than for foreign top executives. It argues that each one of these theories - Marginal Revenue Product Theory, Tournament Theory, Opportunity Cost Theory, Bargaining Theory, and Risk Adjustment Theory - present better explanations for the international CEO pay gap than Board Capture Theory.

Richard Posner, Are American CEOs Overpaid, and, If So, What If Anything Should Be Done about It?  58 Duke L.J. 1013 (2009). Posner notes that American CEO's are on average paid about twice as much as their counterparts in other countries. This is the case even though American CEO's have lower average salaries because bonuses and stock options are much more prevalent in the U.S. Posner argues that in large corporations in which ownership is widely dispersed, incentive based compensation is necessary to address the high agency costs faced by owners. Posner casts blame on directors for failing to limit CEO compensation due to conflicts of interest and "mutual back scratching." Having concluded that CEO's are overpaid, Posner discusses social costs arising from overcompensation such as investors choosing less valuable investments to avoid overcompensating firms, and talent diversion to industries in which overcompensation is most frequent. Posner gives four major solutions to the problem of excessive CEO pay: (1) greater disclosure to investors regarding pay, (2) backloaded executive compensation to tie pay to future firm performance, (3) steeply increased marginal income tax rate of persons with high incomes, (4) more contentious proxy fights between competing slates of directors.

Miscellaneous

Ronald J. Gilson, Value Creation by Business Lawyers: Legal Skills and Asset Pricing, 94 Yale L.J. 239 (1984). The author asserts that "what business lawyers do has value only if the transaction on which the lawyer works is more valuable as a result [of his participation]." Gilson explores the idea of business lawyers as "transaction cost engineers," and briefly discusses the changes in legal education necessary for an increased focus on training lawyers to promote "private ordering." For more material in this vein, see Symposium: Business Lawyers and Value Creation for Clients, 74 Or. L. Rev. 1 (1995).

Frank Easterbrook, Derivative Securities and Corporate Governance, 69 U. Chi. L. Rev. 733 (2002). Easterbrook sets out to shed light on the overlooked relationship between derivative instruments and the corporations whose securities are the physical assets on which the derivatives depend. He argues that derivatives overcome many obstacles to accurate pricing of corporate securities and hence to the design of optimal corporate charter terms. Investors can use derivative trading, which is less costly and more efficient than trading in corporate shares, to make it clear to entrepreneurs which governance devices are most highly valued. 

Internet resources: Information on Delaware corporation law is provided by the Delaware Secretary of State's office on-line at http://corp.delaware.gov/. The EDGAR database, maintained by the Securities & Exchange Commission, is a treasure trove of corporate information, http://www.sec.gov/edgarhp.htm. For a gateway to the growing literature on unincorporated business associations, see Professor Larry Ribstein's personal website http://home.law.uiuc.edu/~ribstein/.

Last updated December 2010

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