Business Associations Prof. Steinitz Spring 2016
What is a firm?
Short hand economist use, not a legal concept
Legal equivalent is a business association
Economist analyze it as a nexus of contracts:
Define contracts as a voluntary exchange—> implies they are not binding therefore, there are other mechanisms to enforce—> like Reputation
What is a business association?
Legally defined type of legal entity —> personhood as governed by relevant statute e.g., the corporation
What is a corporation?
Type of business association governed by state corporate statue act it is incorporated under.
Sources of law
Governed predominantly by state law
Primarily statute—> therefore the analysis starts with the statute.
After 1929, federal government stepped in and began to regulate
Securities Act of 1933 and Securities Exchange act of 1934
Regulate Public Corporations (Not private)
Public corporation’s shares are offered to public through issuance
General divide is between the state and federal regulation although there is so bleeding over.
Why organize into Firms? (Robert Coase Reading)
Defined firms as aggregation of nexus of contracts enabled by agency law.
Saw evidence of his theory of the frim in the law of agency, which provides for a principal to direct an agent by fiat rather than negotiating of agents acts at arms-length in the open market
Prevents owner from having to enter each and every contract, has agent do it instead
Allows for economies of scale
Cost advantages that enterprises obtain due to size, output, or scale of operation, with cost per unit of output generally decreasing with increasing scale as fixed costs are spread out over more units of output
Ways to invest in a business.
Shares/ units: held by owner who is entitled to residual profits
Paid after bond owners, employees, government etc.
Potential conflicts between
Shareholders v. bond holders
Majority shareholders v. Minority shareholders
Law comes in to protect minority
Towards the bottom in bankruptcy proceedings.
Makes you a creditor
Governed by a different body of law
Gets fixed income
Ways Corporations die
Dissolution (process is usually governed by statute)
Cost Ancillary to the transaction
Ex. Lawyer fees in a merger
The cost to ‘do’ business
The firm is a mechanism to reduce transaction costs
Costs/benefits created within a business
Mirror image of externality
Can be positive or negative
Costs/benefits that go outside the business
All of tort law is designed to deal with externalities.
Can be positive or negative
Theory of the Corporation
Theory of the firm
Corporation as a Nexus of Contracts
Privilege —> Also underlies theory of social responsibility
Historical—> Use to have to have a piece of legislation to be able to incorporate, now done through statute.
Idea is that the corporation was a privilege from the government.
Idea that in order for firms to do business they need to be able to operate in the economy as a person,
This way they can enter into contracts, own property, sue and be sued.
Legal fiction created for economic reasons—> for efficiency
Business entities as contracts between business owners and the business.
Steinitz breaks up privilege into privilege and contracts
Social Responsibility (Corporate Social Responsibility: CSR)
CSR overseas—> correct for the negative externality (in the U.S. this is done through Tort Law)
Benefit from positive externalities
Argument against CSR
Corporation is already giving back in jobs and economy by doing business.
Purpose of the Corporation is to do business
Let the money go to the shareholder in residual income and let them make their own decision on what to donate.
Behavioral economic term, where one party has a benefit they overvalue it and are unwilling to give it up
Challenge trying to come up with a partnership agreement after the fact
person making decision uses an initial piece of information to make subsequent judgments.
Example: price where they show original price they price is the sale price (because it is where the supply/demand curve is) but you see it as value at original price. “It’s a bargain”
In settlement if you start at higher point more likely to settle higher all other facts the same include reservation point (lowest person is willing to take)
Agency problems —> Legally: Conflicts of interest
Core challenge in a firm is agency costs
Cost of delegation
Costs that occur by virtue of the fact that by delegating you create a conflict of interest
As you separate control they will exercise their discretion which may have a coast
Cost to supervise
In-house legal cost
Where monitoring fails
Incurred by the agent. An agent may commit to contractual obligations that limit or restrict the agent’s activity. Ex. A manager may agree to stay with a company even if the company is acquired.
Conflicts of interest systemic to business firms
Managers v. Owners
Managers giving themselves raises/bonuses
Minority v. Majority share holders
Creditors v. Owners
How to deal with agency Cost
Impose contractual duties
Disclosures —> S.C.C
Have a duty of loyalty
A person in a special relationship of trust, the law imposes upon them duties of care and loyalty.
Gorton v. Doty (Who’s an agent)
Woman lends car to football coach, coach gets into accident. Injured person in car sues the owner.
Issue: was the coach acting as an agent of the owner, making the owner liable
Holding: yes, agency existed. The dispositive fact was that the owner Doty placed a condition on the driver that he
t to engage in economic activity
Protects assets of the business form creditors of the owners
Converse of owner shielding
Limited liability is a form of owner-shielding
A venture’s owner is liable only for the obligations of the venture to the extent that he or she has invested in the venture, and cannot lose anything beyond that investment.
Asset portioning as value adding.
Protecting the owners from the creditors of the business and the business from the creditors of the owners can increase value by increasing efficiency. People are more likely to invest because the risk is minimized.
Words of agreement
Boiler plate provisions.
Title of contract/type
Entities: be super specific (down to punctuations), where incorporated.
Type of declarations
Background of contracts/context
Geared toward court/arbitrator
Possibly regulatory entities —> keep regulatory provisions in mind
Project financing setting
Typically, a corporation from developed world investing in third world.
In this setting a more robust recital needed because it is a politically charged deal
Aimed at general population to do avocation work.
Way to memorialize the agreement of the meaning of specific words
Manifest an agreement of what a term means.
May do six things
Expand or limit the dictionary meaning of a word
May clarify the meaning of a word or phrase
May resolve the meaning of a word that is ambiguous
May explain the meaning of a technical word or phrase
Can be sued to express a concept that is specific to the transaction
Can list all the things to which a word or phrase refers
Can explain the meaning of a word or phrase by listing it significant characteristics.
Words of agreement
“Now, therefore the parties agree”
they state for the record that the parties have agreed
Tell the parties how to perform the principal objective of contract
Provisions in which the parties agree to perform the main subject matter of the contract; and
Here, the parties promise to accomplish a contract’s primary objective
The consideration provisions, generally the payment of money
Sets forth contract’s financial terms