Enterprise Organization Outline

ENTERPRISE ORGANZATIONS-NICHOLAS HOWSON-WINTER 2011

I. Economic and Legal Aspects of the Firm

· In law, the classic firm is referred to as a sole proprietorship

· Central actor: entrepreneur

o Directs the business and exercises business judgment

o Accepts full responsibility for the business by being the residual guarantor and claimant

§ Unlimited liability

· Modern firms often separate ownership from control as there are many owners

o Does this destroy the underpinnings of the capitalist system as managers have reduced ownership/incentives

§ Three possible responses: Society bends managers to will of shareholders OR recognize that managers have great power and only their sense of morality and public service constrain. Third possibility is to treat interests of shareholders and managers as subordinate to society

· Jensen and Meckling’s view focuses on the contractual nature of firms

o Takes focus away from corporations as social institutions, also removes social responsibility view

· Principal-agency view: shareholders are principals

o This differs from the traditional legal principal-agency view

§ No inherent right of control or inherent obligations

o Can be contractually defined, especially to prevent shirking

§ Direct monitoring of managers, bonding agreements that may result in penalties if objectives are not met, and incentive schemes

§ These programs also carry a cost

o Gains are reduced by cost of agency-limiting programs and residual losses

· Many firms prefer to have some issues of adjudication performed internally, which requires lawyers to modify the corporate governance structure. BUT also pay attention to external laws/regs

· Investors take a comparative and ex-ante approach

o Comparative: weigh plausible alternatives

o Ex-ante: goal is to predict which strategy will lead to most optimal result

· Risk, potential outcomes, and risk preferences

· Contracts can reduce certain risks (like profit sharing, ownership) but also introduce transaction costs

· Bounded rationality- while we are rational, there are limits on our ability to do so. Our predictions may not be accurate

· Opportunism- individuals follow their self-interests. Opportunism is self-interest seeking with guile: individuals who act opportunistically seek to further their own ends by taking advantage of information deficits of those they deal with

· In discrete contracting, the parties have no previous contractual obligations and all contingencies are contracted for, but this is often not the case

o Most likely to be successful for short-term relationships

· Relational contracting does not seek to address all contingencies, but sets up a governance structure that will address problems later

· One of the advantages of creating a firm is that it does not require cooperation by al, but can make one ultimately responsible, but co-ownership can still complicate things and employees do not want to be victimized

· The state can provide certain firm structures (“state-provided standard contracts”)

· Some terms may be altered, but there are legal boundaries as to how much they can be

· Government rules

o Tailored rules- designed to allow contracting parties to use the exact rule(s) they, themselves, would use.

§ Bounded rationality problems

§ Any default rule could be said to be a tailored rule for parties that do not vary the rule by contract

o Majoritarian rules- designed to provide investors that most similarly situated parties would prefer

§ Those who don’t like them can alter them

o Penalty default rules motivate parties to contract around the default ruleàforce parties to write their own rules

· Firms compete in several markets

o Product market

o Capital market

o National securities markets

o Labor and manager markets

· Most firm activity is governed not by contracts, but by Non-Legally Enforceable Rules and Standards (NLERS)

o Sometimes it’s corporate culture

Restatement of Agency § 1.01: unifying ownership and control in a few, while others agree to serve as employees/agents

Fiduciary duties are part of the legal framework that specify what an agent owes to the principal

Community Counseling Service, Inc. v. Reilly

· π sought records from former salesman based on allegations of disloyal promotion, ∆ countersued for recovery of salary and commission payments

· ∆ was to submit daily reports to manager and used his employer’s distribution. ∆ stopped filing reports and later resigned because he wanted more money and wife’s illness.

o Contract req’d 30 days but there was an agreement to effect earlier

· Customer later asked for ∆’s personal services rather than those of π, π told ∆ he was still obliged to work for π

o Reilly testified this agreement only happened after effective resignation, but it is clear that Reilly intended to work for himself and did.

· The usual rule is that former employee may compete with employer after employment period is over, but may not use trade secrets/confidential info

· However, Reilly did not have the right to solicit himself prior to employment end as it went against the purpose of his employment.

· Question: does this mean ∆ forfeits wages for the period or profits of his disloyalty at the time

Hamburger v. Hamburger

· Son worked loading and unloading trucks, delivering wire, and other manual laboràmoved to sales, helped grow the business, but uncle grows resentful and son’s employment status is shaky

o Resigns without notice and starts own business, solicited customers from former employer.

o Uncle claims these activities commenced during his employment and customer info was confidential from his father in violation of fiduciary obligations

o Not illegal because an employee is free to make logistical arrangements while still an employee. Solicitation of employees occurred only after employment and customer info was general info he acquired.

§ You can take remembered information with you

§ An employer who wishes to restrict an employee’s subsequent behavior must use a non-competition agreement

§ Customer information is not a trade secret if the info was readily available from published sources

Fiduciary duty imposes a general obligation to act fairly

Courts have imposed some limits to at-will employment

Foley v. Interactive Data Corp.

· π was fired, but claims oral assurances of job security except for good cause and says that ∆ written “Termination Guidelines” set the procedure for termination process

· π claims he was fired for revealing information about crimin