Corporate Law and the Theory of the Firm

Reconstructing Corporations, Shareholders, Directors, Owners, and Investors

Wm. Dennis Huber

• Publisher: Routledge
• Year: 2020
• ISBN:
  9781000061840
• Edition: 1
• Topic: Business
• Subtopic: Business Law
• Index: Business

Dozens of judicial opinions have held that shareholders own corporations, that directors are agents of shareholders, and even that directors are trustees of shareholders' property. Yet, until now, it has never been proven. These doctrines rest on unsubstantiated assumptions.

In this book the author performs a rigorous, systematic analysis of common law, contract law, property law, agency law, partnership law, trust law, and corporate statutory law using judicial rulings that prove shareholders do not own corporations, that there is no separation of ownership and control, directors are not agents of shareholders, and shareholders are not investors in corporations. Furthermore, the author proves the theory of the firm, which is founded on the separation of ownership and control and directors as agents of shareholders, promotes an agenda that wilfully ignores fundamental property law and agency law. However, since shareholders do not own the corporation, and directors are not agents of shareholders, the theory of the firm collapses.

The book corrects decades of confusion and misguided research in corporate law and the economic theory of the firm and will allow readers to understand how property law, agency law, and economics contradict each other when applied to corporate law. It will appeal to researchers and upper-level and graduate students in economics, finance, accounting, law, and sociology, as well as attorneys and accountants.

Part I

Foundations

Property law, agency law, trust law, and partnership law

With the review of common law and contract law completed, we can turn our attention to the foundations of corporate law in order to understand the contradictions of corporate law. This part will review, in order, property law, agency law, trust law, and partnership law. While property law, agency law, and trust law are woven into the fabric of corporate law, partnership law is not directly incorporated into corporate law. However, property law, agency law, and trust law are inherent in partnership law, and it is therefore necessary to compare and contrast how property law, agency law, and trust law are applied to partnerships with how they are applied to corporations.

Corporate law is an amalgamation of contract law, property law, agency law, and trust law. It is a product of both state common law and statutory law. Corporations whose stock and other securities are publicly traded are also subject to federal laws with respect to the securities. Corporations are, of course, subject to a wide variety of state and federal laws and regulations pertaining to such things as the environment and workers’ safety. While those issues are important, this book is concerned only with the laws governing the legal structure of the corporation and the implications of those laws on the economic theory of the firm.

In Part I, I perform a rigorous analysis of property law, agency law, trust law, and partnership law. This part serves as the foundation that exposes the logical fallacies and legally invalid arguments of the mantra of “separation of ownership and control” that undergirds the economic theory of the firm and exposes the contradictions inherent in corporate law.

Beginning with Berle and Means’s The Modern Corporation and Private Property (first published in 1932) to Jensen and Meckling’s Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, the doctrine of the separation of ownership and control and the economic theory of the firm based on the agency theory of the shareholder-director relationship has achieved a cult-like following, a secret society where admission is granted to law students and economics students after a period of indoctrination where questioning the legal premises on which the doctrine is founded is not permitted.

This part not only questions those premises but also proves that they have no legal validity.

1 Property and property law

Introduction

Economics, as defined by every introductory economics textbook, is the science of the allocation of scarce resources. Property in its various forms constitutes resources to the owner of the property. Property law is the legal structure that determines who owns the property (e.g., government or private persons), which resources are allocated and controlled (labor or capital), and how they are allocated and controlled (market or centrally planned by the government).

In this chapter, I review the basics of private property law, including types of private property and ways by which private property may be owned. Understanding basic property law is necessary to understand the relationship between corporations and property, shareholders and property, and shareholders and corporations. It is important to understand the nature of private property and property laws in order to understand the allocation of resources of production and the economic theory of the firm.

Private property in the United States

Our modern concept of private property¹ and property laws is centuries old, arising in common law. Private property, although not property law, is entrenched in the American Constitution. The Bill of Rights guarantees that “No person shall … be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.”² The Fourteenth Amendment further guarantees that “[No] State [shall] deprive any person of life, liberty, or property, without due process of law.”³

The Constitution never defines “property” or how property may be owned. Nor does the Constitution form the basis of property laws. Definitions of property and laws of property are left to the states and to common law. As the Supreme Court ruled in Ruckelshaus v. Monsanto Co.,⁴ “[p]roperty interests … are not created by the Constitution. Rather, they are created and their dimensions are defined by existing rules or understandings that stem from an independent source such as state law.” Only state law can define the legal parameters of ownership of private property as a result of the Tenth Amendment: “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”⁵

State property laws are largely the product of common law, but also some statutory law, depending on the type of property. According to Posner (2014), common law, when viewed from an economic perspective, includes the law of property (creating and defining property rights) and the law of contracts (facilitating the voluntary transfer of property rights).

Prior to examining laws concerning private property, we must understand the various types of private property and methods of ownership. The method of ownership of private property depends on the type of property. There are various types of private property, each of which must be considered prior to examining private property within the context of shareholders and corporations. For example, the Delaware General Corporation Law⁶ and New York Business Corporation Law⁷ itemize the types of property a corporation may own, how it may acquire property, and what the corporation may do with the property. The Delaware General Corporation Law also declares that shares of stock owned by a stockholder are personal property.⁸

Furthermore, economics, as defined by every introductory economics textbook, is the science of the allocation of scarce resources. Property in its various forms constitutes resources to the owner of the property. Property law is the legal structure that determines who owns the property,⁹ which resources are allocated to production, who controls the resources, and how they are allocated and controlled (Yuille, 2015). It thus behooves us to understand types of private property and laws of ownership of private property in relation to shareholders and property, shareholders and corporations, and corporations and property. Property law determines the ownership of resources and the ownership of the firm¹⁰ while agency law determines the relationship of directors and shareholders, which is discussed in the next chapter.

Berle and Means’s (1991) The Modern Corporation and Private Property failed to provide a systematic discussion of private property or property rights or how such rights are established or forfeited or an analysis of types of property and types of ownership (Hessen, 1983). A study of corporate law and the theory of the firm must begin with a study of types of private property and property law.

Types of private property

The term “property” has no universally accepted definition within Anglo-American jurisprudence (Yuille, 2015; Morales, 2013). Property refers to a legal interest in, or relationship to, either a physical or non-physical object, or a bundle of rights recognized in the object.¹¹

Property describes the rights the owner has over a thing, rather than the thing itself. “[N]early everyone agrees that the institution of property is not concerned with scarce resources themselves (‘things’) but rather with the rights of persons with respect to such resources” (Morales, 2013, quoting Thomas Merrill, Property and the Right to Exclude, 77 Nebraska Law Review, 1998).

In rem rights attach to the thing, i.e., attach to the property itself, while in pesonam rights attach to the owner of the thing (Morales, 2013).¹² In rem rights are generally rights pertaining to real property¹³ while in pesonam rights generally pertain to personal property (Morales, 201...