Historical Theories of Corporate Legal Personality by lau20349


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Richard Swedberg (2003) wrote that an economic sociology of law – “a
sociological analysis of law’s role in economic life” – doesn’t yet exist.

                • What should be the main task of an economic
                sociology of law – to show how society shapes
                legal institutions & their influence on the economy?

                • Why isn’t the law and economics perspective –
                which uses the neoclassical rational actor model –
                sufficient for understanding these relationships?

• What historical shifts in legal theories of the firm
have altered conceptions of corporate governance
and shareholder control?

• How might corporate governance structures and
practices be changed to foster greater stakeholder
accountability and corporate social responsibility?
                    Weber on the Law
Weber defined law as “externally guaranteed by the probability
that physical or psychological coercion will be applied by a staff of
people in order to bring about compliance or average violation.”

               Weber linked three authority types to distinct legal systems:
               Traditional authority: rule through customary laws
               Charismatic authority: laws established through inspiration
               Legal authority: rational law (legislative & administrative)

Medieval merchant courts held at fairs
and markets adjudicated disputes.
Lex mercatoria laid the foundations
for modern capitalism’s many legal
institutions, including international
contracting & arbitration at the heart of
globalized economy since the 1960s.
      Legal Institutions of the Economy
 A key task for economic sociology is to explain the emergence
 of legal institutions crucial to efficient functioning of capitalism.
                     • Private property rights – what is alienable?

                     • Inheritance of property across family generations

                     • Contracts – about property & employment rights

                     • Corporation as legal personality – limited liability

“If [corporate] directors are to become
in effect trustees, in whose interests
should they act? One answer is that
they should become trustees for the
interests of society as a whole.”
            James Coleman (1990:578)
                    Law and Economics
Law and economics, at U of Chicago, uses neoclassical economics to
analyze legal problems, including regulation and corporate governance.

                 • Positive L&E uses economic-efficiency analysis to predict
                 the effects of alternative legal rules. For example, an L&E
                 analysis of tort laws would contrast cost-benefit outcomes
                 from applying a strict-liability rule vs. a negligence rule.
                 • Normative L&E seeks to make policy recommendations
                 based on the economic consequences of public policies.

 Judge Richard Posner argued that a just decision should rearrange
 social conditions to maximize the social wealth of affected parties.

     Pareto efficiency - a stringent legal exchange rule where one party can be
     made better-off, only if no other party is made worse-off

     Kaldor-Hicks efficiency - a less-strict rule allowing exchanges that increase
     net social wealth, perhaps by making a side payment to any injured party

 What recent legal decisions exemplify efficiency principles? Why did
 Posner abandon his mediation of the 1999 Microsoft antitrust suit?
                    Coase’s Theorem
Ronald Coase (1960) analyzed the economic efficiency solution for
allocating property rights in externality disputes, such as air pollution.
                  An externality occurs whenever a decision creates costs (or
                  benefits) to stakeholders other than the decision-maker.
                  In absence of transaction costs, all governmental allocations
                  of property are equally efficient, because interested parties
                  will bargain privately to correct any externalities. But, a
                  corollary implies that, in the presence of transaction costs, a
                  government could minimize inefficiency by allocating the
                  property initially to the party assigning it the highest utility.

Coase’s example: If two radio stations initially
interfere by broadcasting in the same frequency
band, in absence of TC, that station able to profit
most has an incentive to pay the other station not
to interfere. But, because transaction costs can’t
be neglected, governmental decisions on initially
allocating property rights matter a great deal.
Why is Coase’s Theorem unable to explain disputes about stray cattle
damaging neighboring property in Shasta County (Ellickson 1991)?
          Legal Theories of the Firm
In the 19th century, U.S. statutory and case law assigned legal
private property rights to a business’ owners - its proprietors,
partners, or a corporation’s shareholders (stock owners)
                 Purchasing corporation’s equity (stock, shares) entitles
                 a risk-taking shareholder to:
                 • dividends paid from any future company profits
                 • capital gains by re-selling shares in stock market
                 • “residual assets” if firm dissolves, after debtors paid

Natural entity theory of corporate governance treats
firm as a “corporate personality” originating in the
contractual relations between private individuals

Why were legal theory & courts so slow to develop alternative
theories about employee rights and consumer protection?
                        Corporate Governance
Today’s legal theory treats the corporation as its stock owners’
private property. An elected board of directors supervises firm by
setting strategy, appointing & monitoring top execs. Only goal of
leaders is to maximize financial returns on shareholder investments.

Corporate executives’ sole responsibility to shareholders is
“to conduct the business in accordance with their desires,
which generally will be to make as much money as possible
while conforming to the basic rules of the society, both those
embodied in law and those embodied in ethical custom.”
     Milton Friedman. 1970. “The Social Responsibility of Business Is to Increase
     Its Profits” New York Times Magazine Sept. 13:33

                        Stakeholder theory asserts firms also have a social
                        responsibility to serve the interests of nonowners.
                              “Business is permitted and encouraged by the law
                              because it is of service to the community rather than
                              because it is a source of profits to its owners.”
                                     E. Merrick Dodd. 1932. “For Whom Are Corporate Managers Trustees?”
                                     Harvard Law Review 45:1145-1148.
          Top Executives Take Power
During 20th century, widespread dilution of stock ownership enabled
top executives to take de facto control of many large corporations
(Berle & Means 1932 The Modern Corporation and Private Property)
Owner-management separation gave control over company assets &
operations to executives often more motivated by power, prestige, job
security than by shareholders’ short-term profit-maximization goals.

                                         • Recommend a hand-
                                         picked candidate slate, no
                                         • Solicit shareholders’
                                         proxy cards authorizing
                                         the execs to vote those
Management control via board elections
                                         • SEC rules permit a firm
Although shareholders elect              to pay its execs’ election
directors, the top executives            expenses
control access to the proxy
machinery needed to win seats            • Insurgents lack adequate
  Institutional Investors are Revolting
Recent institutional investor revolts have tried to make large
corporations more accountable to their shareholders
Campaigns led by giant public pension funds (CalPERS,
TIAA-CREF) facing a classic Exit-Voice dilemma: dumping
their shares would depress stock prices for their pensioners
They forced some CEO ousters & policy reforms, which
boosted company performances and thus raised share prices
                  • Widely publicized “hit lists” of poorly performing firms
                  • Sponsored shareholder resolutions on annual proxy
                  statements; e.g., required minimum directors’ shareholding
                  • “Relational investing” – pension fund managers directly
                  cajole & jawbone execs into take different strategic actions

 Investors had mixed successes in reforming some badly
 mismanaged companies – GM, USAir, IBM, Time Warner
                       The Stakeholder Model
      Stakeholder theory: corporations should be socially responsible
      institutions managed in the public interest. Many organizational
      constituencies have interests other than maximizing firm profits.

               Government                    Investors                    Political
               s                                                          Groups

               Suppliers                       FIRM                      Customers

               s                             Employees                    Communities

(SOURCE: Donaldson, T. and L.E. Preston. 1995. “The Stakeholder Theory of the Corporation: Concepts,
Evidence, and Implications.” Academy of Management Review 20:65-91.)
                     Who Holds a Stake?
To identify stakeholders, R. Edward Freeman applied Immanuel
Kant’s prohibition against treating persons as means, not as ends.
                       “Property rights are not a license to ignore Kant’s
                       principle of respect for persons. Hence, corporations
                       and managers are ethically and morally responsible for
                       the effects of their actions on others.”
                                 (Freeman. 1984. Strategic Management: A Stakeholder
                                 Approach. Boston: Pitman.)

An Oregon sawmill plans to clearcut old-growth forests to
boost shareholder profits. Unemployed loggers and
truckers will benefit from new jobs. Towns will gain tax
revenues from the new spending. Tourist trade will suffer
from destruction of scenic vistas. Indians will lose
salmon runs to polluted streams. How can & should
stakeholder theory reconcile these conflicting interests?

  Which stakeholders are most impacted by the mill’s actions?
  Which stakeholders’ interests should have higher priority?
  How can stakeholders best participate in making these decision?
        Corporate Social Responsibility
CSR covers all the economic, legal, ethical & philanthropic
expectations that societies have about business firm actions.
Beyond earning profits and obeying the law, should good
corporate citizens make decisions & take actions emphasizing:
                              Social responsibility: obligations and
                                 accountability to society
                              Social responsiveness: proactive to
                                 changing social conditions
                              Social performance: achieve successful
                                 outcomes and results

CSR is often depicted as desirable behavior because it satisfies
    • Ethical & moral obligations – “It’s the right thing to do.”
    • Enlightened self-interest – “Doing good is good for business.”
 How might the legal system change to promote more CSR?

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