What is the right normative lens for corporate law? | Holger Spamann | November 27, 2013

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What is the right normative lens for corporate law?

by Holger Spamann Show/Hide

We are now ready to tackle the ultimate question: What is the point of corporate law? Is it merely to facilitate contracting?  If so, what is the best way to do it? If not, what other goals should corporate law aim to advance?

In this context, commentators like to contrast the so-called contractarian and entity views of the corporation. As its name suggests, the contractarian view emphasizes the contractual aspects of the corporation, from drafting the initial charter to executive compensation contracts to customer relationships. By contrast, the entity view emphasizes the importance of the (large) corporation on the life of its constituents and beyond. Commentators tend to associate the contractarian view with an argument for contractual freedom, and the entity view with an argument for more mandatory rules.

In truth, this is a false dichotomy. The views are two sides of the same coin. A corporation is both one or more contracts (the charter above all) and an entity. Contracts can be regulated, and often are — for example, in the criminalization of cartels. And the mere fact that the corporate entity is important for people does not necessarily mean that we think the state should regulate how people organize it.

What the two views do, however, is illustrate the different rationales for corporate law-making. One rationale is to remedy contracting imperfections even between the contracting parties. Another rationale is to prevent externalities on non-contracting parties. U.S. corporate law tends to downplay the latter, perhaps because its perspective has been narrowed by the internal affairs doctrine and the doctrine’s limiting effects on regulation through corporate law. Implicitly, however, U.S. law also seems to fear externalities arising specifically from incorporation. If not, why would a law firm not be allowed to organize as a corporation? Or perhaps it should be allowed? We will approach such questions through Citizens United.

The corporation as a contract

As we have seen, U.S. corporate law grants very extensive contractual freedom. Choose your state. Choose your corporate charter (cf. DGCL 102(b)(1) – read!). Even choose your entity type. For example, anyone not satisfied with DGCL 102(b)(7)’s restrictions on eliminating corporate fiduciary duties can choose a Delaware Limited Liability Company instead, where “[fiduciary] duties may be . . . eliminated by provisions in the LLC agreement; provided, that the LLC agreement may not eliminate the implied contractual covenant of good faith and fair dealing.” Del. LLC Act § 1101©. If that is still not enough, the Delaware statutory trust may help. Cf. Del. Code title 12, ch. 38.

Indeed, why limit permissible charter provisions at all? Once we rely on contracting to get the right result, why stop at particular provisions? In fact, if law is a “product” why not allow private providers to supply it? That is, why require election of any state law for incorporation? Private providers might be better at generating and maintaining private contract forms, registries, and arbitration — instead of, for example, the Delaware General Corporation Law, Secretary of State, and Chancery Court respectively. If the contractual model holds, people’s self-interest will ensure that they choose the most suitable package. The more options, the better.

Perhaps having so many options would make contracting too complex and confusing? That can hardly be a good argument because the existing options allow for plenty of confusion — for example the offer of non-voting shares and complicated voting structures. Many financial contracts are extremely complex, much more complex than we could reasonably expect charters to be — at present, public corporation charters are generally short, overwhelmingly boilerplate, and show very little variation. And the difficulty of evaluating a charter term pales in comparison to that of valuing a business.

Of course, human fallibility can undermine the contractual model (careful, though — it undermines faith in regulation as well). For example, if gullible investors do not price charter provisions correctly, savvy founders will produce bad charters. This might warrant prohibiting certain charter terms. But why stop there? Why not stop investors from investing in bad businesses? In other words, should some agency review the “investment worthiness” of securities before they can be issued to the public? Such review did exist in many states for a long time.

Perhaps the best argument for why charter freedom may not produce optimal results even if people generally contract well is charters’ long life. Drafters cannot foresee everything, and corporations can be around for a very long time. Then again, drafters know this, so they could build whatever flexibility they desire into their charter.

The corporation as a social entity

Of course, the contractarian view of the corporation is not the only possible view. In fact, for most of the 20th century, a different view prevailed in the U.S. and elsewhere. This was the view of the corporation as a social entity. This view saw a much larger role for mandatory law in structuring the entity and in regulating the entity’s interaction with the world. For example, the most famous account of large U.S. corporations in the 20th century, Adolf Berle & Gardiner Means’ “The Modern Corporation & Private Property” (1932; 1968) reviewed the dispersion of (family) ownership and the rise of professional management to conclude (pp. 310-313):

“Observable throughout the world . . . is this insistence that power in economic organization shall be subjected to the same tests of public benefit which have been applied in their turn to power otherwise located.  . . .

“By tradition, a corporation ‘belongs’ to its shareholders . . . and theirs is the only interest to be recognized as the object of corporate activity. Following this tradition, and without regard for the changed character of ownership, it would be possible to apply in the interests of the passive property owner [i.e., shareholders] the doctrine of strict property rights . . . . Were this course followed, the bulk of American industry might soon be operated by trustees for the sole benefit of inactive and irresponsible security owners.  . . .

“[Another] possibility exists, however. On the one hand, the owners of passive property, by surrendering control and responsibility over the active property, have surrendered the right that the corporation should be operated in their sole interest . . . At the same time, the controlling groups [i.e., managers], by means of the extension of corporate powers, have in their own interest broken the bars of tradition which require that the corporation be operated solely for the benefit of the owners of passive property.  . . . The control groups have . . . cleared the way for the claims of a group far wider than either the owners or the control. They have placed the community in a position to demand that the modern corporation serve not alone the owners or the control but all society.  . . .

“In still larger view, the modern corporation may be regarded not simply as one form of social organization but potentially (if not yet actually) as the dominant institution of the modern world.  . . .

“The rise of the modern corporation has brought a concentration of economic power which can compete on equal terms with the modern state — economic power versus political power, each strong in its own field. The state seeks in some aspects to regulate the corporation, while the corporation, steadily becoming more powerful, makes every effort to avoid such regulation.  . . .  The future may see the economic organism, now typified by the corporation, not only on an equal plane with the state, but possibly even superseding it as the dominant form of social organization. The law of corporations, accordingly, might well be considered as a potential constitutional law for the new economic state.  . . . "

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  1. 2 Show/Hide More Citizens United v. Federal Election Com'n (US 2010)
    Original Creator: Holger Spamann

    In this very controversial decision, the Supreme Court’s conservative majority held that a prohibition of corporate expenditures on certain types of speech violates the First Amendment. The decision implicates important legal issues of free speech, stare decisis, and judicial restraint. For our purposes, however, I have edited the case down to the passages dealing directly with the constitutionality of, and rationale for, distinguishing corporate from non-corporate speech. Please focus on this distinction.


    The First Amendment reads, in relevant part:

    “Congress shall make no law … abridging the freedom of speech, or of the press.”


    As a preliminary matter, consider the following questions:

    1. Does a literal reading of the First Amendment protect corporate expenditures?
    2. Does an originalist reading of the First Amendment, adopted in 1791, protect corporate expenditures? You may recall that incorporation required a special act of the legislature well into the 19th century. Cf. Justice Scalia’s concurrence and Justice Stevens’ dissent.


    In answering the latter question, you may want to distinguish between different types of corporations. In particular, many of the arguments and precedents that the Justices discuss relate to news, media, and political organizations, and the petitioner in the case is a non-profit advocacy organization funded mostly by donations from individuals. In this class, we are primarily interested in business corporations.


    The main questions to consider are:

    3. Do the Justices treat the corporation as an abstraction—a convenient way of summarizing legal relationships between individual human beings? Or as a “concentration of economic power which can compete on equal terms with the modern state” (Berle and Means)? Or as something different altogether?
    4. Do the “the procedures of shareholder democracy” protect dissenting shareholders when they disagree with speech approved by (a) boards and managers or (b) majority shareholders? Should they? What would be the contractarian answer?
    5. What other arguments for distinguishing corporate and individual speech do the Justices consider?
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April 23, 2017

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