Economic and Legal Aspects of the Firm
Sole Proprietorship: one person owns 100% of the business. Complete control and responsibility for the business, keeps all profits and bears all losses. There is no legal distinction between the proprietor and the business.
Business Organization: uses more than simple market transactions and contractual exchanges to organize the means of production. In most cases, these are jointly owned.
The Business Lawyer: must understand clients’ economic goals, relationships with investors/partners. Must design an organization that suits clients’ needs and that will protect them if disputes should arise. The chosen organization determines the legal relationships or the participants, their responsibilities for business debts, and their tax liability.
Business Law: a set of answers to common questions (how to organize investment, liability, profit, risks, influence in making decisions) that arise with respect to every business. Function to protect reasonable expectations of individuals who jointly own firms. Provide off the rack solutions to common organizational problems.
– Mandatory Rules: corporation has no choice but to follow. Few and far between.
– Default Rules:if parties say nothing, these rules apply. Parties can write around them.
The reasonable expectations of those who jointly own a firm is a reasonable return on their investment of money (money capital) and time (human capital)
– the problem with figuring out where to invest capital is that you have incomplete knowledge.
– Ex ante decision-making: deciding before the known outcome.
– Expected return: to evaluate the likely return of a particular investment based on the probability of each possible outcome, multiply each outcome by the probability and add them. The expected return can change depending on the type of investment, on the possibilities after investment.
Concept of Risk: an investment with more than one possible return has risk. Government securities are generally considered a risk free investment, serves as a baseline for other investments (need a higher rate of return than government securities to get others to invest). The bigger the range of outcomes, the greater the risk.
– Minimizing Risk: increasing the probability of return or increasing the amount of return
– Risk preference: risk preferring, risk averse, risk neutral will be affected by the personal situation of each investor (wealth, etc.)
Transaction Costs
Must reduce transaction costs to be an efficient organization.
– Bounded Rationality: investors cannot anticipate and plan for every contingency that might affect the venture. The business lawyer should try to create a flexible design.
– Opportunism: one participant may try to take advantage of the other
– Team-Specific Investment: investment is team specific if and to the extent that the investment has a lesser value if re-deployed outside the team. The investment is worth more because of the existence of the team. Problems arise because each asset is owned by a different individual. One can choose to leave the team if it suits him, or take advantage (opportunism). One can get away with being opportunistic because of bounded ra
of the fiduciary duty eliminates the need to write a contract dealing with all responsibilities and contingencies.
Residual Claimant: a sole proprietor gets all profits and bears all losses. He is the last in line to receive money (after paying employees, etc.).
Employment at Will: deters agents from violating their fiduciary duty. The principal has no incentive to fire good employees. The principal does not have to worry about people doing a good job because agents will act to make sure they do not get fired. By agreeing to at will, the agent is signaling that he is a good employee.
Efficiency: one employer cannot do everything himself. 3rd parties need to know they are in effect dealing with the principal (the principal is bound by the agent’s actions).
Authority: what an agent is authorized to do, by contract or by law.
R2A §7: Actual authority is the agent’s power to bind the principal through consent
manifested by the principal directly to the agent
R2A §8: Apparent authority is the agent’s power to bind the principal through consent
manifested by the principal to the 3rd party (explicit or implicit)
R2A §8A: Inherent authority is a gap-filling device that arises from a desire to protect the
reasonable expectations of 3rd parties who deal with agents
