Progressive Corporate Law

Lawrence E Mitchell

• Publisher: Routledge
• Year: 2019
• Print ISBN: 9780367284435
• eBook ISBN: 9781000308310
• Edition: 1
• Topic: Law
• Subtopic: Corporate Law
• Index: Law

Reflecting recent re-examinations of the nature and purpose of the modern publicly held corporation, Progressive Corporate Law introduces the reader to alternative perspectives within the field. The contributors to this volume are loosely bound both by their rejection of the prevailing paradigm of the corporation as a public good designed exclusively for the maximization of private profit and by their affirmative goal of designing corporate laws that accord better with the corporation's political and social realities. The resulting series of visions emphasizes communitarian themes of efficiency and morality of responsibility, altruism, and unity within the corporate form as well as between the corporation and the broader society. Progressive Corporate Law is important reading for business executives, lawyers, policymakers, and others who are concerned with the role of corporations in modem life. Designed to act as a springboard for stimulating discussion, it will be a valuable supplement to courses and seminars in corporate law and business ethics.

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Communitarianism in Corporate Law: Foundations and Law Reform Strategies

David Millon

The Problem of Nonshareholder Vulnerability

Recently, a diverse group of scholars has challenged corporate law’s traditional commitment to the shareholder primacy principle. Shareholder primacy mandates that management—the corporation’s directors and senior officers—devote its energies to the advancement of shareholder interests. If pursuit of this objective conflicts with the interests of one or more of the corporation’s nonshareholder constituencies, management is to disregard such competing considerations. For much of this century, corporate law’s principal task has been to develop rules that increase the likelihood that management will act in the interests of shareholders. Shareholder voting rights and defined fiduciary duties enforceable by shareholder derivative actions are particularly important. Imperfect though these mechanisms may be, they reflect an effort to develop corporate governance structures designed to strike a balance between shareholder accountability and managerial discretion.

Those scholars who have challenged the shareholder primacy principle may be referred to as communitarians, because—as will appear more fully below—their work focuses on the sociological and moral phenomenon of the corporation as community, in contrast to the individualistic, self-reliant, contractarian stance that dominates current academic discourse in corporate law. The catalyst for this communitarian turn in corporate law has been concern about the harm to nonshareholders that can occur as a result of managerial adherence to the shareholder primacy principle. Efforts to maximize shareholder wealth are often costly to nonshareholders and often come at the expense of particular nonshareholder constituent groups. For example, a corporation may find that one of its several plants can no longer be operated profitably. Management’s duty to the shareholders mandates that it consider closing the plant in order to avoid further losses. Doing so will result in lost jobs. Other members of the community in which the plant is located will suffer as well. Tax revenues will decline, as will charitable giving and other contributions of the corporation and its employees to the life of the community; established creditor, customer, and supplier relationships will be terminated, perhaps leading to further unemployment; and lost jobs will impose added strain on social services budgets. Shareholders gain (by avoiding losses) at the expense of these nonshareholders, many of whom have made nontransferable investments of human and financial capital in the reasonable expectation of a continued, long-term corporate relationship. Nevertheless, from a corporate law standpoint, none of these clearly foreseeable harms to nonshareholders is relevant to management’s decisionmaking. Instead, management’s duty is to focus solely on the interests of the corporation’s shareholders, weighing the likely costs and benefits to them alone of closing the plant.

The problem of nonshareholder vulnerability emerged starkly during the hostile takeover explosion of the 1980s. Shareholders clearly benefitted from an active market for corporate control. Bidders offered substantial premiums over market prices, and even shareholders whose corporations were not targets arguably stood to gain from the heightened managerial diligence that the threat of a change in control encouraged. However, hostile takeovers, built upon mountains of debt, imposed unprecedented pressures on corporations to generate current income and cut operating expenses. Employees in particular were threatened by abrupt layoffs or plant closings, and other nonshareholder constituencies often suffered as well.

The social costs of hostile takeovers highlighted a problem lurking within corporate law’s traditional commitment to shareholder primacy. Management’s duty of exclusive regard to shareholder interests necessarily threatened nonshareholder interests in any situation in which there was a conflict. While hostile takeovers seemed the most likely arena in which such conflicts might emerge, any corporation faced with real financial pressures might find it necessary to sacrifice nonshareholders on the altar of shareholder wealth maximization. Certainly heightened international competition in product markets and the technological transitions necessary to meet (or foster) changes in consumer demand only increase the likelihood of such trade-offs.

The Contractual Corporation

During the last ten years or so, a positive and normative theory of the corporation has grown increasingly influential in legal academic circles. This theory dismisses the idea of the corporation as a real entity—a distinctive “thing” having an existence separate from its component parts—as nothing more than a convenient fiction. Instead, it describes the corporation as a “nexus of contracts” among all suppliers of inputs (such as capital, labor, materials, and services) that contribute to the production process. The corporation is decomposed into a web of self-seeking, bilateral market transactions.¹

Many of these contracts include terms that address the circumstances and preferences of the parties. Suppliers of labor, materials, services, and credit enter into contracts with corporate management that specify with particularity the extent of nonshareholders’ claims against corporate assets. These contracts are more or less tailormade, regardless of whether the terms are actually negotiated between the parties.

In contrast to these nonshareholder contracts, shareholders typically contract with management by entering into the standard-form agreement supplied by the relevant state corporate law code and corpus of common law. This “off-the-rack” contract includes a collection of terms that shareholders would typically prefer, so including them greatly reduces transaction costs. Many (though not all) can be modified by express contract if the shareholders so desire.

As residual claimants, shareholders subject themselves to the risk that they will earn no return on their investment once all nonshareholders’ fixed claims against corporate assets have been paid. It is therefore in the shareholders’ interest that management maximize the corporation’s profits. Accordingly, one key term in the shareholders’ contract with management is the open-ended injunction that management act in “the best interests of the corporation and its shareholders.” This term is necessarily vague, because it is impossible as a practical matter to specify ex ante precisely what management ought to do in concrete situations. Voting rights and fiduciary duties imposed on management (enforceable by the shareholder derivative suit) are designed to allow shareholders to hold management accountable, and shareholders alone benefit from these accountability mechanisms because of the uniqueness of their position within the corporation’s nexus of contracts.

The neoclassical economic analysis on which the contractarian position rests acknowledges that nonshareholders may be affected negatively by managerial pursuit of shareholder wealth maximization. Conceptually, such effects are a negative externality incidental to shareholders’ efforts to maximize return on their capital through the use of professional managers acting on their behalf. However, the fact that nonshareholders may suffer as a result of corporate efforts to maximize shareholder wealth does not necessarily establish a legitimate claim for legal protection. Many people routinely suffer losses from the operation of market forces. This is the fate of the firm unable to produce as efficiently as a competitor. The constant transitions necessitated by a dynamic market economy impose costs on many affected parties. As far as the law is concerned, much of this is noncompensable; it is damnum absque injuria.

Contractarians insist that employees, creditors, and other vulnerable nonshareholder constituent groups can protect themselves from such externalities through contract and should do so to the extent that protection is desired. For example, employees concerned about uncompensated layoff can bargain for explicit promises of long-term job security, severance pay and reimbursement for retraining costs, or other forms of protection. Failure to insist upon such protection implies ex ante consent to the possibility of layoff whenever necessary to serve shareholder interests, presumably in return for other more highly valued benefits. Accordingly, ex post judicial intervention on behalf of nonshareholder constituencies who have not bargained for protection represents an illegitimate wealth transfer from shareholders to the benefitted nonshareholder group. Nonshareholders gain a benefit they have not bargained for, and the gain comes at the shareholders’ expense. From the contractarian perspective, such transfers are unjust because they cannot be justified on the basis of shareholder consent.

The contractarian position rests on an underlying commitment to the sanctity of shareholder property rights. Share ownership implies broad freedom to maximize share value. The law should not require shareholders to yield this right unless they have consented ex ante to limitation. In other words, if third-parties suffer from shareholder efforts to exploit the value of their property, the burden should be on the affected parties to self-protect by means of legally enforceable contract. That normative conclusion follows from the positive vision of the corporation as nothing more than a web of bilateral exchanges among self-seeking property owners.

The Communitarian Turn

There are three elements to the communitarian critique of the contractarians’ view of corporate law. The first challenges key assumptions about the feasibility of nonshareholder self-protection through bargain. The second is more fundamental. It asserts that, even if self-protection through bargain were entirely feasible in a technological sense, disparities in bargaining power would prevent at least some nonshareholder constituencies from obtaining adequate protection from the costs of shareholder wealth maximization. This argument appeals to a conception of justice that insists that people are entitled to more than merely what they can bargain and pay for. Or, stating the same idea in terms of obligation rather than entitlement, community members owe each other duties of mutual regard and support. Finally, communitarians have offered a positive vision of corporate relationships that differs from that of the contractarians and has correspondingly different normative implications. This perspective grounds obligation on a rich foundation of mutual trust and interdependence rather than limiting it to the bare bones of actual contractual terms and rests on a vision of the corporation as a community rather than a mere aggregation of self-seeking individuals whose relationships are defined solely by contract.

The Inadequacy of Self-Protection

Communitarians assess the social costs of shareholder wealth maximization more broadly than do contractarians. The contractarians’ economic approach tends to focus on more obviously monetizable considerations, disregarding more amorphous but no less real costs. For example, the cost of a worker’s layoff may be more than just the discounted present value of the income that he or she would have earned, less any offset due to reemployment. Despair and low self-esteem may follow layoff, and even the worker who finds another job may suffer from heightened feelings of insecurity and incur psychological difficulties in adjusting to a new work environment. These transition and morale costs are surely difficult to value in dollar terms, but they are no less real for that reason. They too should be factored into the welfare calculation, such that even a laid-off worker who finds another job at comparable pay may be worse off for having been laid off. Likewise, the morale costs of a lost job in one locality would not necessarily be offset fully by creation of a new, comparably compensated employment opportunity elsewhere.

Communitarians also tend to define more broadly the universe of people potentially affected adversely by shareholder wealth maximization. A plant closing, for example, may involve more than employee layoffs and termination of various commercial relationships. Consumers may also lose access to distinctive products, and the local community will often lose tax revenues and charitable contributions. Management-level employees may also have significant involvements in civic and social activities.

Communitarians draw an important lesson from their fuller appreciation of the magnitude and complexity of the social costs of shareholder wealth maximization. There appears to be more at stake than contractarians are typically willing to acknowledge. The costs of transactions undertaken for the benefit of shareholders represent a problem of genuine social and political significance, rather than more or less trivial—and therefore readily disregarded—inevitabilities of productive activity.

One might still respond that, however big the problem might be, shareholder property rights still put the onus on nonshareholders to protect themselves by contract. Bargaining will then generate efficient levels of nonshareholder protection. Communitarians respond that effective nonshareholder self-protection through bargain often is not practically feasible.

Particular kinds of conduct likely to be harmful to nonshareholders may be difficult to foresee and to specify contractually with adequate precision. This may result from informational advantages enjoyed by management, which has direct access to confidential strategic plans and has no incentive to disclose them voluntarily to employees or other nonshareholder constituencies. Workers may be totally unaware of plans to shut down a plant and shift production to another location, and may have been misled by statements or other behavior seemingly suggesting a long-term commitment to their welfare. Even if there is some sense that such shifts are always possible, even in the face of management indications to the contrary, employees are much less likely to bargain for protection than they would be if they knew of management’s actual plans to close a plant or of a more general corporate policy to lay off workers whenever it is in the shareholders’ interest to do so.

In addition to informational disparities, our competitive market economy demands constant product innovation and technological change. Developments likely to benefit shareholders and harm nonshareholders may be unforeseeable to management and nonshareholders alike. Even complete candor on the part of management may leave nonshareholders in a position of significant vulnerability. While the general risk may be apparent, the precise parameters are unknowable. Nonshareholders must therefore bargain about such matters in the dark, or, more likely, simply disregard them because the risk cannot be valued.

Even where future contingencies are foreseeable, the parties may choose not to bargain about them, believing that the remoteness of the risk does not justify the time needed to decide ex ante how the costs should be apportioned. They may also choose to leave particular matters unresolved because of the difficulties involved in assessing accurately the costs that various hypothetical scenarios are likely to generate. The parties may also recognize that their respective attitudes toward various future events may themselves change over time, devaluing the benefits of ex ante investments in bargained-for solutions.

Even with full knowledge of risks and preferences, individual nonshareholders may face serious problems in negotiating for protection because the terms of their relationship to the corporation often will not be subject to individualized bargaining. This is typically true of investors in corporate bonds, who must accept the terms already negotiated by an investment bank, as well as for lower-level employees, who typically must accept a standardized package of compensation and work assignment terms. Collective bargaining over compensation, working conditions, and the like is still possible in the unionized sector, but that sector is already very small relative to the workforce as a whole, and it continues to shrink. Absent a union, members of nonshareholder constituencies who share common interests and preferences would encounter difficulties in coord...

Table of contents

• Cover
• Half Title
• Series Page
• Title
• Copyright
• Contents
• Foreword
• Preface
• Acknowledgments
• About the Editor and Contributors
• 1 Communitarianism in Corporate Law: Foundations and Law Reform Strategies
• 2 Working Toward a New Paradigm
• 3 Some Observations on Writing the Legal History of the Corporation in the Age of Theory
• 4 The Death of Contractarianism and the Vindication of Structure and Authority in Corporate Governance and Corporate Law
• 5 Experiencing Limited Liability: On Insularity and Inbreeding in Corporate Law
• 6 Game Theory and the Restoration of Honor to Corporate Law’s Duty of Loyalty
• 7 Trust. Contract. Process.
• 8 Promoting Economic Justice in Plant Closings: Exploring the Fiduciary/Contract Law Distinction to Enforce Implicit Employment Agreements
• 9 The Legitimacy of Multinational Corporations
• 10 On the Frontier of Capitalism: Implementation of Humanomics by Modern Publicly Held Corporations — A Critical Assessment
• About the Book