ECONOMIC & LEGAL ASPECTS OF THE FIRM
I. Generally
A. Focus on Delaware corporate law b/c most publicly traded firms are incorporated in DE
B. Study of corporations has significance both in planning & litigation settings
C. Model Business Corporation Act not used much
D. What is a “firm”? –
1. Some say that a firm consists of a proprietor & ees
2. Others say a firm consists of not only proprietor/ee but also those w/ whom firm has business
3. One of the main reasons to create a firm is that it is efficient – the owner can tell his ees what to do instead of King in the market
4. “firm is line b/t resource allocation by command & resource allocation by price/K – the firm is the line b/t fiduciary duty owed to the proprietor & non owed to the proprietor”
II. Goal of Corporate Attorney
A. Planning
1. Provide efficient transactions & organizational forms @ the least possible expense for clients
2. Minimization of transaction costs to which the client is exposed e.g. cost of drafting, cost of litigation, future adjustments, etc.
3. Help with human capital and money capital
B. 3 Transaction Cost Concepts
1. bounded rationality – our limited ability to process rationally – too many variables that limit the accuracy of judgments
2. opportunism – self interest seeking w/ guile – withholding info when you that the info you are w/holding would cause the other person to act in a different way & taking advantage of the other person’s ignorance
a. can think of law as a way of providing safeguards against the risk that the other party is acting opportunistically, either @ the outset or in the future by remedies
b. e.g. bureaucracies – a system of organization – it’s easy in this kind of system for someone to shirk their duties or to divert resources from their intended use
c. markets as a possible way to limit opportunism
i. e.g. employment market & reputation – reputation is one way in which we can learn a/b someone that they may or may not tell us truthfully, thus curbs not only opportunistic behavior to some extent but also quality of services – runs both to er & ee
d. Ks can also curb opportunism – can decide @ the outset how certain problems, should they come up, will be dealt w/, like a prenup for a marriage
3. Team (firm) specific investment (value) – value that is unique to the firm – if there is significant team specific value, it will be worth less @ its next best use in comparison to its team specific use w/ the firm
a. e.g. marriage in which one spouse works & the other doesn’t – the one who doesn’t work creates value that is not necessarily valuable in the market – the destruction of the marriage necessarily, then, means the destruction of the value created by the nonworking spouse
b. e.g. law firms want to work their new associates as hard as possible b/c everything they learn isn’t team specific & another firm can lure them away, taking the firm’s investment w/ them
III.Agency & Fiduciary Duty
A. 2nd Restatement of Agency: (1) Agency is the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf & subject to his control, & consent by the other so to act. (2) The one for whom the action is taken is the principal (er). (3) The one who is to act is the agent (ee).
B. Fiduciary duty: duty on the part of the ee to look out for the interests of the er over his own
1. This duty runs from ee to er, but not er to ee – one sided duty – the er owes no duty, not candor to the ee in terms of a legally enforceable fiduciary duty
a. Justifications for the one-sidedness of the relationship ???
2. The parties must Kually agree to be bound in this way
3. FD runs all the way down the line to every single ee – it’s just that the lower down an ee is, the less opportunity the ee may have to take advantage of the er
4. FD is a standard form K w/in the firm – b/c the body of law deals w/ the relationship b/t er & ee, the distinction b/t ee & independent Ker is important
C. Employment @ will relationships
1. This is a two sided relationship in which the ee or the er may fire or quit for any reason,
2. This is subject only to public policy protections ie whistleblower
3. Employment-@-will & team-specific value
a. if an ee has a high potential team-specific value, then ee & er will want some kind of K b/c the higher the team specific value, the less you are going to be willing to rely on ordinary rules of employment & agency laws
b. b/c there will be a time when one party or other wants to be opportunistic, want to make sure to create some incentives an barriers to supplement agency/employment law
D. Fiduciary Limits on Agent’s Rights of Action
1. Community Counseling Svcs,, Inc. v. Reilly (1963)
a. Facts: D = fund raiser. He gave notice that he was quitting but arranged to do work after he left his er for people that he solicited during course of his work for his er while he was employed Er sought an accting.
b. Holding: “until the employment relationship is finally severed however, the ee must prefer the interests of his er to his own. CAN’T: solicit for himself future business which his employment requires him to solicit for his er…above all, he should be candid w/ his er & should w/hold no info which would be useful to the er in the protection & promotion of his interests”
c. NOTE: maybe he should have won – lost b/c he cut too close, shouldn’t have left so much ammo for his ers
2. Hamburger v.
rights, the most important of which is the right to the residual profits
V. The Corporate Form: a typical corporation separates ownership & management functions into three specialized roles: directors, officers, & shareholders, who collectively have the rights & duties of the proprietor
A. The rules
1. Can be: standard form K rules, default rules or immutable rules – this makes sense b/c people decide whether or not to enter into a certain kind of relationship where the rules are Kable, thus, K relationship
2. Kinds of Rules
i. Default versus Immutable Rules
ª Most off-the-rack rules are “enabling” à Parties can modify if they want.
ª If lawmakers are efficiency-minded, they’ll set default rules to maximize parties’ ability to adapt to changed circumstances while minimizing their exposure to opportunism.
ª Immutable rules – cannot be “trumped” by private ordering
© Prevent negative effect on 3d parties when joint owners to adopt a diff rule.
© Or designed to protect the joint owners from their own contracting mistakes.
© Key: Ask yourself WHOSE interests are served by immutable rules
ii. Tailored, Majoritarian, & Penalty Default Rules
ª Tailored rules – to give contracting parties the exact rule they themselves would choose if they were able to bargain costlessly over the matter in dispute.
© Availability of tailored results via ex post judging allows parties to avoid costs of making a K covering all possible contingencies.
© But providing a tailored rule is problematic – bounded rationality. How do lawmakers know what specific parties want?
© Even if courts get “tailored results,” such an achievement may not be much – litigation costs in arriving @ the tailored result.
ª Majoritarian rules – to provide parties w/ the result that most similarly situated parties would prefer (often used w/ investors)
© Lawmakers make assumptions about the contracting needs of investors & provide rules that will suit a large number of them.
© Those who don’t like the rules can vary them or choose another business form that has more suitable rules for their needs.
ª Penalty default rules – to motivate 1+ contracting parties to K around the default.
