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corporate law: full summary of the book (GRADE: 9)
- Instelling
- Universiteit Van Amsterdam (UvA)
summary of the book for corporate law. Uva year 2
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Voorbeeld van de inhoud
Summary bookCh 1
1.2 what is a corporation?
Google: Organizing a business in corporate form allows a company to function independently from the owners of the business. And one
or more people may operate a company in corporate form of business in many states.
Business corporations have a fundamentally similar set of legal characteristics— and face a fundamentally similar set of legal problems
—in all jurisdictions.
the basic legal characteristics of the business corporation: legal personality, limited liability, transferable shares, delegated management
under a board structure and investor ownership. Together, they make the corporation especially attractive for organizing productive
activity. But these characteristics also generate tensions and tradeoffs that lend a distinctively corporate character to the agency
problems that corporate law must address
in market economies, almost all large-scale business firms adopt a legal form that possesses all five of basic characteristics of business
corporation. Most small jointly owned firms adopt this corporate form as well, although sometimes with deviations from one or more of
the five basic characteristics to fit their special needs.
A principal function of corporate law is to provide business enterprises with a legal form that possesses these five core attributes. By
making this form widely available and user-friendly, corporate law enables business participants to transact easily through medium of
corporate entity, and thus lowers costs of conducting business
Principal focus in this book: reducing ongoing costs of organizing business through corporate form. Corporate law does this by
facilitating coordination between participants in corporate enterprise, and by reducing scope for value-reducing forms of opportunism
among different constituencies.
Corporate laws everywhere share core features which can be understood as serving to reduce the costs for participants of organizing
their activities in business firms
Agency problem -> Most of corporate law understood as responding to 3 principal sources of opportunism endemic to such
organization:
1. conflicts between managers and shareholders
2. conflicts between controlling and non-controlling shareholders
3. conflicts between shareholders and corporation’s other contractual counterparties, including creditors and employees.
any form of jointly owned enterprise faces coordination costs and engenders conflicts among its owners, managers, and third- party
contractors
the particular characteristics of the corporate form matter a great deal, since it is the form chosen by most large-scale enterprises—
and, as a practical matter, the only form that firms with widely dispersed ownership can choose in many jurisdictions. In our view, this is
because its particular characteristics make it uniquely effective at minimizing coordination costs. Moreover, these same features
determine the particular contours of its agency problems.
Shareholders enjoy limited liability, general partners in partnership do not.
1.2.1 legal personality
Nexus of contracts = firm often characterized as. Ambiguous description, invoked to emphasize that most of important relationships
within a firm (including among firm’s owners, managers & employees) are contractual in character. Does not distinguish firms from
other networks of contractual relationships.
Nexus for contracts = more accurate. Firm serves as common counterparty in contracts with suppliers, employees and customers,
coordinating actions of these multiple persons through exercise of its contractual rights. First and most important contribution of
corporate law, is to permit a firm to serve this coordinating role by operating as a single contracting party that is distinct from various
individuals who own or manage the firm. In doing so, it enhances ability of individuals to engage together in joint projects. Core element
of firm as nexus for contracts is “separate patrimony.” (=demarcation of a pool of assets that are distinct from other assets owned,
singly or jointly, by firm’s owners (shareholders)).
Firms entitlement of ownership over its designated assets include rights to use the assets, sell them, make them available for
attachment by its creditors. Assets conceived as belongings to firm rather than firm’s owners, they are unavailable for attachment by
owners’ personal creditors.
Core function of separate patrimony is “entity shielding” (=shielding assets of entity – corporation – from creditors of entity’s owners)
Entity shielding involves two rules of law: priority for business creditors and liquidation protection
1. priority rule = grants to creditors of firm, as security for firm’s debt, claim on firm’s assets that is prior to claims of personal creditors
of firm’s owners. Rule shares by modern legal forms including partnerships Consequence of this rule: firm’s assets are, as default rule of
law, automatically made available for enforcement of contractual liabilities entered into name of firm. By bonding firm’s contractual
commitments, rule makes these commitments credible.
2. liquidation protection = individual owners of corporation (shareholders) cannot withdraw their share of firm assets at will, nor can
the personal creditors of individual owner foreclose on owner’s share of firm assets. Such withdrawal or foreclosure would force partial
or complete liquidation of the firm. So this rule serves to protect going concern value of firm against destruction by individual
shareholders or their creditors. Not found in other standard legal forms for enterprise organization such as partnership.
-> strong-form entity shielding = legal entities (business corp) characterized by both rules. Facilitates tradability of firm shares by
isolating value of firm from personal financial affairs of firm’s owners.
-> weak-form entity shielding = found in partnerships. Characterized only by priority rule
Benefits of these two rules (creditor priority & liquidation) reinforce one another where the assets in question comprise contractual
agreements. Part of firm’s value creation comes from interaction of contracts it has negotiated. These rules assure counterparties that
their performance will be delivered by reference to value generated by that bundle of contracts and associated assets, amongst which
there will be complementarities. Not only does this make it easier to negotiate such contracts, also facilitates liquidity on part of
shareholders. Easier for owner of corp to transfer her shares than it would be for sole proprietor to transfer her contracts
For firm to serve effectively as contracting party two other types of rules also needed:
1. authority-delegated management = rules specifying to third parties the individuals who have authority to buy and sell assets in name
of firm, and to enter into contracts that are bonded by those assets. Participants to large extent free to specify delegation of authority
by contract amongst themselves but background rules needed, to deal w/situations where agents induce third parties to rely on mere
appearance of their authority. Rules treated as separate core characteristic. Corporate managers (B.O.D) power to bind company in
contract.
2. procedures = must be rules specifying procedures by which both firm and counterparties can bring lawsuits on contracts entered into
in name of firm. Corporations subject to rules that make such suits easy to bring as procedural matter. They eliminate any need to
name, or serve notice on, the firm’s individual owners.
, Outcomes achieved by these 3 rules (entity shielding, authority, procedure) require dedicated legal doctrines to be effective. When
absent, could not be replicated simply by contracting among a business’s owners and their suppliers and customers. Law here serves to
reduce costs of doing business. Entity shielding doctrine needed to create common expectations, among a firm and its present and
potential creditors, concerning effect that a contract between a firm and one of its creditors will have on security available to firm’s
other creditors.
Rules governing the allocation of authority are needed to establish common expectations as to who has authority to transfer rights
relating to corporate assets prior to entering into a contract for their transfer. And procedures for lawsuits need to be specified by the
state, whose third- party authority is invoked by those procedures. This need for special rules of law distinguishes these three types of
rules from the other basic elements of the corporate form discussed here, almost all of which could in theory be crafted by contract
even if the law did not provide for a standard form of enterprise organization that embodies them
company is itself a person, in the eyes of the law, it is straightforward to deduce that it should be capable of entering into contracts and
owning its own property; capable of delegating authority to agents; and capable of suing and being sued in its own name.
1.2.2 limited liability
The corporate form effectively provides a default term in contracts between a firm and its creditors whereby the creditors are limited to
making claims against assets that are held in the name of (or “owned by”) the firm itself, and have no claim against assets that the
firm’s shareholders hold in their own names.
Limited liability shields the firm’s owners (the shareholders) from creditors’ claims. this facilitates diversification. With unlimited
liability, the downside risk borne by shareholders depends on the way the business is carried on. Shareholders will therefore generally
prefer to be actively involved in the running of the business, to keep this risk under control. This need to be “hands-on” makes investing
in multiple businesses difficult. Limited liability, by contrast, imposes a finite cap on downside losses, making it feasible for shareholders
to diversify their holdings. It lowers the aggregate risk of shareholders’ portfolios, reducing the risk premium they will demand, and so
lowers the firm’s cost of equity capital.
“owner shielding” provided by limited liability is the converse of the “entity shielding” described above as a component of legal
personality. Entity shielding protects the assets of the firm from the creditors of the firm’s owners, while limited liability protects the
assets of the firm’s owners from the claims of the firm’s creditors. Together, these forms of asset shielding (or “asset partitioning”)
ensure that business assets are pledged as security to business creditors, while the personal assets of the business’s owners are
reserved for the owners’ personal creditors. As creditors of the firm commonly have a comparative advantage in evaluating and
monitoring the value of the firm’s assets, and an owner’s personal creditors are likely to have a comparative advantage in evaluating
and monitoring the individual’s personal assets, such asset shielding can reduce the overall cost of capital to the firm and its owners. It
also permits firms to isolate different lines of business—and focus creditors’ monitoring efforts accordingly—by incorporating separate
subsidiaries
1.2.3 transferable shares
Fully transferable shares in ownership are another basic characteristic of the business corporation that distinguishes corporation from
partnership and other standard-form legal entities. Transferability permits the firm to conduct business uninterruptedly as the identity
of its owners changes, thus avoiding the complications of member withdrawal that are common among ex: partnerships, cooperatives,
and mutuals. This enhances the liquidity of shareholders’ interests and makes it easier for shareholders to construct and maintain
diversified investment portfolios.
Transferability of shares is the flipside of the liquidation protection that the corporation’s legal personality assures to its contractual
counterparties. because counterparties can be confident that the “bundle of contracts” that constitutes the firm will be kept together,
there is no need for a rule requiring owners to continue to participate. In the absence of a legal entity—that is, if the owner contracts as
sole proprietor—then counterparties would be concerned that assignment of their contracts would reduce the value of their expected
performance and hence wish to restrict it. It is precisely for these reasons that all jurisdictions have a default rule prohibiting the
assignment of most contracts without the prior consent of the other contracting party. At the same time, however, these consent
requirements make it more difficult for the owner to sell the business and liquidate her investment. Legal personality addresses these
problems by enabling the simultaneous transfer of all, but no less than all, of a firm’s contracts by transferring the corporation’s shares.
In other words, it permits the free transferability of all of a firm’s contracts taken together (“bundle assignability”), while preserving the
general default rule that makes individual contracts non-assignable without consent of the contractual counterparty.
Fully transferable shares do not mean freely tradable shares. Even if shares transferable, they may not be tradable without restriction in
public markets, but rather just transferable among limited groups of individuals or with the approval of the current shareholders or of
the corporation. Free tradability maximizes the liquidity of shareholdings and the ability of shareholders to diversify their investments. It
also gives the firm maximal flexibility in raising capital. For these reasons, all jurisdictions provide for free tradability for at least one
class of corporation. However, free tradability can also make it difficult to maintain negotiated arrangements for sharing control and
participating in management. Consequently, all jurisdictions also provide mechanisms for restricting transferability. Sometimes this is
done by means of a separate statute, while other jurisdictions simply provide for restraints on transferability as an option under a
general corporation statute.
For terminology, refer to corporations with freely tradable shares as “open” or “public” corporations, use the terms “closed” or
“private” corporations to refer to corporations that have restrictions on the tradability of their shares, two other distinctions are
important.
1. First, the shares of open corporations may be listed for trading on a stock exchange, in which case we will refer to the firm as a
“listed” or “publicly traded” corporation, in contrast to an “unlisted” corporation.
2. Second, a company’s shares may be held by a small number of individuals whose interpersonal relationships are important to the
management of the firm, in which case we refer to it as “closely held,” as opposed to “widely held.” It is common to speak, loosely, as if
all companies can be categorized as either “public” or “closed” corporations, bundling these distinctions together (and the widely used
term “close corporation” itself embodies this ambiguity, being used sometimes to mean “closed corporation,” some- times to mean
“closely held corporation,” and sometimes to mean both). But not all companies with freely tradable shares in fact have widely held
share ownership, or are listed on stock exchanges. Conversely, it is common in some jurisdictions to find corporations which, though
their shares are not freely tradable, have hundreds or thousands of shareholders, and consequently have little in common with a typical
closely held corporation that has only a handful of shareholders, some or all of whom are from the same family.
Transferability of shares, is closely connected both with the liquidation protection that is a feature of strong-form legal personality, and
with limited liability. Absent either of these features, the creditworthiness of the firm as a whole could change, perhaps fundamentally,
as the identity of its shareholders changed. Consequently, the value of shares would be difficult for potential purchasers to judge.
Ensuring a single price for shares, independent of the wealth of the purchaser, permits securities markets to aggregate information
about the firm’s expected future performance through its stock price. a seller of shares could impose negative or positive externalities
on his fellow shareholders depending on the wealth of the person to whom he chose to sell. It is therefore not surprising that strong-
form legal personality, limited liability, and transferable shares tend to go together, and are all features of the standard corporate form
everywhere. This is in contrast to the conventional general partnership, which lacks all of these features.
, 1.2.4 delegated management with board structure
Standard legal forms for enterprise organization differ in their allocation of control rights, including the authority to bind the firm to
contracts, the authority to exercise the powers granted to the firm by its contracts, and the authority to direct the uses made of assets
owned by the firm. Ex: the default rules applicable to general partnership forms grant power to majority of partners to manage the firm
in the ordinary course of business, while more fundamental decisions require unanimity. Both aspects of this allocation are unworkable
for business corporations with numerous and constantly changing owners, because of information and coordination costs.
Consequently, corporate law typically vests principal authority over corporate affairs in a board of directors or similar body that is
periodically elected, exclusively or primarily, by the firm’s shareholders. More specifically, business corporations are distinguished by a
governance structure in which all but the most fundamental decisions are generally delegated to a board of directors that has four basic
features.
1. First, the board is separate from the operational managers of the corporation. The legal distinction between them formally divides all
corporate decisions that do not require shareholder approval into those requiring approval by the board of directors and those that can
be made by the firm’s hired officers on their own authority. This formal distinction between the board and hired officers facilitates a
separation between, on the one hand, initiation and execution of business decisions, which is the province of hired officers, and on the
other hand the monitoring and ratification of decisions, and the hiring of the officers themselves, which are the province of the board.
That separation serves as a useful check on the quality of decision-making by hired officers.
2. Second, the board of a corporation is elected—at least in substantial part—by the firm’s shareholders. The obvious utility of this
approach is to help assure that the board remains responsive to the interests of the firm’s owners, who bear the costs and benefits of
the firm’s decisions and whose interests, unlike those of other corporate constituencies, are not strongly protected by contract. This
requirement of an elected board distinguishes the corporate form from other legal forms, such as nonprofit corporations or business
trusts, which permit or require a board structure, but do not require election of the board by the firm’s (beneficial) owners.
3. Third, though largely or entirely chosen by the firm’s shareholders, the board is formally distinct from them. This separation
economizes on the costs of decision-making by avoiding the need to inform the firm’s ultimate owners and obtain their consent for all
but the most fundamental decisions regarding the firm. It also permits the board to serve as a mechanism for protecting the interests of
minority shareholders and other corporate constituencies
4. Fourth, the board ordinarily has multiple members. This structure—as opposed, for example, to a structure concentrating authority in
a single trustee, as in many private trusts—facilitates mutual monitoring and checks idiosyncratic decision-making. However, there are
exceptions. Many corporation statutes permit business planners to dispense with a collective board in favor of a single general director
or one-person board—the evident reason being that, for a very small corporation, most of the board’s legal functions, including its
service as shareholder representative and focus of liability, can be discharged effectively by a single elected director who also serves as
the firm’s principal manager.
1.2.5 investor ownership
two key elements in the ownership of a firm: the right to control the firm, and the right to receive the firm’s net earnings. The law of
business corporations is principally designed to facilitate the organization of investor-owned firms—that is, firms in which both
elements of ownership are tied to investment of equity capital in the firm. More specifically, in an investor-owned firm, both the right
to participate in control—which generally involves voting in the election of directors and voting to approve major transactions—and the
right to receive the firm’s residual earnings, or profits, are typically proportional to the amount of capital contributed to the firm.
Business corporation statutes generally provide for this allocation of control and earnings as the default rule.
There are other forms of ownership that play an important role in contemporary economies, and other bodies of organizational law—
including other bodies of corporate law—that are designed to facilitate the formation of those other types of firms. Ex: cooperative
corporation statutes—which provide for all of the four features of the corporate form just described except for transferable shares, and
often permit the latter as an option as well—allocate voting power and shares in profits proportionally to acts of patronage, which may
be the amount of inputs supplied to the firm (in the case of a producer cooperative), or the amount of the firm’s products purchased
from the firm (in the case of a consumer cooperative).
The facilitation of investor ownership became a feature of the corporate form only in the second half of the nineteenth century. Until
then, both investor- and consumer- owned firms worldwide had been routinely organized under a single corporate form. The
subsequent specialization toward investor ownership followed from the dominant role that investor-owned firms have come to play in
contemporary economies, and the consequent advantages of having a form that is specialized to the particular needs of such firms, and
that signals clearly to all interested parties the particular character of the firm with which they are dealing. The dominance of investor
ownership among large firms, in turn, reflects several conspicuous efficiency advantages of that form. One is that, among the various
participants in the firm, investors are often the most difficult to protect simply by contractual means. Another is that investors of capital
have (or, through the design of their shares, can be induced to have) relatively homogeneous interests among themselves, hence
reducing—though definitely not eliminating—the potential for costly conflict among those who share governance of the firm.
Specialization to investor ownership is yet another respect in which the law of business corporations differs from the law of partnership.
The partnership form typically does not presume that ownership is tied to contribution of capital, and though it is often used in that
fashion, it is also commonly employed to assign ownership of the firm in whole or in part to contributors of labor or of other factors of
production—as in partnerships of lawyers and other service professionals, or simply in the prototypical two-person partnership in which
one partner supplies labor and the other capital. As a consequence, the business corporation is less flexible than the partnership in
terms of assigning ownership. To be sure, with sufficient special contracting and manipulation of the form, ownership of shares in a
business corporation can be granted to contributors of labor or other factors of production, or in proportion to consumption of the
firm’s services. Moreover, as the corporate form has evolved, it has achieved greater flexibility in assigning ownership, either by
permitting greater deviation from the default rules in the basic corporate form (e.g. through restrictions on share ownership or trans-
fer), or by developing a separate and more adaptable form for closed corporations. Nevertheless, the default rules of corporate law
continue to be generally designed for investor ownership, and deviation from this pattern can be awkward. The complex arrangements
for sharing rights to earnings, assets, and control between entrepreneurs and investors in high-tech start-up firms are a good example.
There has been further specialization even amongst investor-owned companies, with the recent emergence of special forms of “public
benefit” or “community interest” corporations designed to accommodate the needs of hybrid firms that, while investor owned, also
commit to the pursuit of a specified social objective. In other instances, state-owned enterprises (SOEs) embrace the corporate form,
hence permitting the government to share ownership with private investors. Because the state is seldom, if ever, a typical financial
investor, state ownership entails a degree of heterogeneity in the shareholder base that exceeds that of the typical investor-owned
firm, with potential for unique conflicts of interest. Sometimes core corporate law itself deviates from the assumption of investor
ownership to permit persons other than investors of capital— for example, creditors or employees—to participate in either control or
profit-sharing, or both. Worker codetermination is a conspicuous example. The wisdom and means of providing for such non-investor
participation in firms that are otherwise investor- owned remains one of the central controversies in corporate law,
Most jurisdictions also have one or more statutory forms—such as the U.S. nonprofit corporation, the civil law foundation, and the UK
company limited by guarantee— that provide for formation of nonprofit firms. These are firms in which no person may participate
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