CORPORATIONS – SALE – FALL 2006
ECONOMIC AND LEGAL ASPECTS OF THE FIRM
State-Provided Governance Structures
i. Default v. Immutable Rules
1. Default Rules: enabling rules that can be modified or changed
a. Set by lawmakers so as to maximize team members’ ability to adapt to changed circumstances while minimizing their exposure to opportunism
b. Get default rules if you don’t make them up yourself
c. Most rational investors would choose these rules
d. Meant to lessen transaction costs
2. Immutable Rules: cannot be “trumped” by private ordering
a. Cannot contract around these rules
i. Lawmakers fear the negative effect on third parties of allowing firms to adopt a different rule
ii. To protect firm members from their own contracting mistakes
3. Some rules can be part default and part immutable
ii. Tailored, Majoritarian, and Penalty Default Rules – Types of default rules.
1. Tailored Default Rules: gives parties the exact rule that they would themselves choose if they were able to bargain costlessly over the matter in dispute (in a cost free environment)
a. Hard to pick tailored rule ex post
b. Availability ex post allows parties to avoid the costs of negotiating and executing a contract specifically covering all possible contingencies.
c. Availability of tailored result to be provided by ex post judging may discourage:
i. Settlement of disputes because there is no normal rule that the parties can expect will apply to their unique case.
ii. May also discourage ex ante contracting because it is not clear what rule is to be contracted around.
d. Advocates speak literally and seek the result each particular litigant would have chosen.
2. Majoritarian Rules: designed to provide investors with the result that most similarly situated parties would prefer (in a cost free environment)
a. Lawmakers make assumptions about the contracting needs of prospective members of the firm and provide rules that will suit a large number of them.
b. Rules may be varied or they may simply choose another business form with a more suitable set of rules.
c. Advocates speak metaphorically and seek the rule that will best protect the rational ex ante expectations of the parties similarly situated to the contracting parties.
3. Penalty Default Rules: designed to motivate one or more contracting parties to contract around the default.
a. The goal of penalty default rules is NOT to economize ex ante transaction costs but it instead to force the parties to specify their own rules ex ante instead of relying on a default rule provided by law.
b. Motivated by lawmakers desire to force parties to share information about their true intentions and to avoid social costs of providing rules to parties via ex post judging, the cost of which is partially subsidized by society
The Firm and Agency
1. Agency law is the set of standard form rules that provide a backdrop for contracts or market transactions among team members
2. Governs both relations betwe
t the public at large the court will likely find that the termination did not violate public policy.
iv. Agency Law and Relations with Creditors
1. Rule: A third party who deals with an agent does so at his peril and the agent’s actions will bind the principal only if the principal has manifested his or its assent to such actions.
2. Manifestations of consent:
a. Actual authority:
i. R/S Agency 7 – Authority
ii. Principal expressly manifests consent directly to the agent
1. Can be done orally or in writing
2. May be implied
a. If Agent is authorized to accomplish a goal, and attaining it reasonably or commonly requires other acts, the agent is constructively deemed to have received implied authority to perform those acts.
b. Apparent authority (ostensible authority):
i. R/S 8 – Apparent Authority
ii. Stems from principal’s words/actions which cause third parties to reasonably believe the agent was authorized.
1. Created expressly or implied
There must be acts of the principal (firm) to have apparent authority. There has to be connection to the principal.