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The Economic Structure of Corporate Law.

Over the past two decades, there has been an almost obsessive devotion among lawyers to working out the implications of Ronald Coase's 1937 article, the "Nature of the Firm." Henry Manne's writing during the 1960s initiated the project, and others, like Richard Posner and Kenneth Scott, who edited the Economics of Corporation Law and Securities Regulation (1980), have regularly underscored its progress by publishing collections of essays. One can hope that this collection of essays by Frank Easterbrook and Daniel Fischel (for the most part previously published) will mark an end to that obsession and allow students of business corporations to resume a more encompassing approach to the problems of both organizing production and regulating the resulting organizations.

The authors' analysis, one they mapped out quite succinctly in a 1989 Columbia Law Review article, "The Corporate Contract," focuses on two means of regulating corporate control: the elaboration of rules that perfect capital markets and of rules that curb managerial power. "Why," they ask, "does corporate control allow managers to set the terms under which they will administer corporate assets? Why do courts grant more discretion to self-interested managers than to disinterested regulators? Why do investors entrust such stupendous sums to managers whose acts are essentially unconstrained by legal rules?". They argue that market adjustments circumscribe the implicit risks, that "economic rationality is implicit in corporate law". Specifically, they draw on available financial and economic studies of capital markets and corporate control transactions. More generally, they rely on two sorts of claims about market rules: 1) that competition for corporate control is a more cost-effective check on managerial abuses of power and suboptimally performing firms than more direct forms of government protection; and 2) that contracting generally gives rise to more cost-effective "spontaneous ordering" of market conventions than spontaneous government intervention.

This book is largely a theoretical legal argument of relatively little interest to readers of history, but it nevertheless represents a distinctive period in the history of U.S. corporate and economic regulation. In that regard, the authors play out some relevant ideas with considerable refinement and attractive writing. Many of the ideas are occasioned by the subject of their chapter 8, entitled "The Incorporation Debate and State Antitakeover Statutes," in which "two of |the book's~ themes run headlong into each other." On the one hand, state corporation law "works like a standard-form contract in promoting the wealth of investors"; on the other, antitakeover provisions found in forty states' corporation laws tend to inhibit investor wealth. Will this tension resolve itself in the long run through investors' market adjustments, or should the federal government intervene to limit state protection of managers and shareholders in target firms? "Competition," the authors suggest, "does not necessarily drive laws to the top, but it drives them up. Federal laws face less competition; it is harder to move to France than to Nevada." Easterbrook and Fischel handle a variety of other "hot" topics in corporation law and securities regulation, ranging from tender offers and appraisals to insider trading and remedies for securities fraud.

Rather than attempting to review at greater length the authors' arguments, many of which are already familiar to those who read this literature, I will sketch out a history that places the book in its context. We are perhaps completing a regulatory cycle that began during the 1920s. At that time, federal and state regulation of managerial control over corporate policies was relatively weak. Federal law was limited to antitrust concerns and prohibitions on corporate political participation, and state regulation had been substantially diluted by interstate competition and the U.S. Supreme Court's constitutional immunizing of corporate properties under the guise of "corporate personality." Just before the start of the New Deal, Adolf Berle and Gardiner Means systematically elaborated the legal theories available for corporate regulation: specifically, in Book 2, chapters 7 and 8, of The Modern Corporation and Private Property (1932), they contrasted the legal constructs for direct regulation ("trust") and market regulation ("contract") of corporate control. Their analysis of the securities markets and their regulatory proposals, Berle would later claim, became the "foundation for Federal legislation begun in 1933." Meanwhile, Berle's guidelines for fashioning more direct regulations based on the legal device of "trust" became the staple of state corporation law and also, somewhat later, began making inroads into the analyses of corporate stakeholder relationships by federal regulatory agencies such as the Securities and Exchange Commission and the Federal Trade Commission.

Generally speaking, judicial implementation of the trust concept seemed to keep managers in control of publicly held corporations reasonably honest; as commentators, courts, and administrators elaborated it during the 1950s, moreover, trust came to require that managers be faithful to the interests of all the firm's principal stakeholders--that is, the quasi-property interests of dependent workers and consumers as well as the interests of shareholders. By the 1960s, however, it had become increasingly apparent to advocates on the Right and the Left that this regulatory regime allowed managers to serve none of the stakeholders' interests (in the name of all); managers could pursue somewhat self-serving strategies that rendered firm performance suboptimal. The Left called for more (effective) government regulation of managers, in particular to promote full employment policies; the Right, most notably Henry Manne, called for deregulation that would invite private competition for corporate control, enhance managerial performance, and ensure the corporation's service as a vehicle for capital accumulation. Following a brief upsurge in government regulation during the late 1960s and 1970s, the market, or "contract," view began winning out. Theory, including "law and economics" (an academic orientation to which Easterbrook and Rischel adhere), "financial agency theory," and "transaction-cost analysis" eventually combined with changing circumstances, including capital market computerization, the rise of institutional investment and junk bonds, increased foreign investment and competition, and revised campaign financing tactics, to promote market-regarding deregulation.

Easterbrook and Fischel, along with others, have essentially been addressing the question: how far should deregulation of the financial markets be extended and under what guise? The resulting literature has inevitably informed regulatory policies and perhaps rendered formerly intervention-minded members of Congress somewhat the wiser, but the focus on one part of the production equation (capital contributions and shareholder-manager relations) without attention to managerial control over other parts seems myopic. Indeed, the authors themselves concede that "It is much easier to move investment dollars than to relocate a factory or a work force." Accordingly, the reshaping of corporate regulation along contract lines, largely to promote investor welfare and potentially at the expense of the goodwill and capacities of other groups intrinsic to the production process, underscores the point that arguments for regulatory reform based on corporate theory (such as the one presented in this book) must be judged not merely by their claims to reason and efficiency, but also in light of an ongoing battle for politically ordered redistribution.

Lawrence S. Zacharias is associate professor in the School of Management, University of Massachusetts, Amherst. He has published articles on the history and theory of the corporation and is currently working on a series of historical essays on legal and technological development in the United States.
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Author:Zacharias, Lawrence S.
Publication:Business History Review
Article Type:Book Review
Date:Sep 22, 1993
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