Corporations Outline
I. Basic Concepts and Terminology 2
II. Organizing the firm: Selecting a Value Maximizing Governance Structure__ 3
III. The Law of Agency(Introduction to Fiduciary Duties)____ 6
IV. Traditional Noncorporate Business Associations 8
VI. The Power to Manage and Bind the Firm 12
VII. The Corporate Form 14
VIII. The formation of the Corporation and the Governance Expectations of the Initial Participants 17
IX. The National Market System and the Efficient Market Hypothesis 20
X. The role of Federal Law for Publicly Held Corporations 22
XI. Fiduciary Duty, Shareholder Litigation, and the Business Judgment Rule 26
XII. Excursion on Corporate Liability (Piercing the Corporate Veil) 44
XIII. Mergers and Other “Friendly Control” Transactions 47
XIV. Hostile Takeovers 57
XV. Insider Trading and Rule 10b-5 60
I. Basic Concepts and Terminology
a. What is a firm?
i. The Firm
1. The “firm” is what we call the set of relations that arise when resources are allocated by the entrepreneur via commands to her employees rather than the set of relations that arise when an entrepreneur allocates resources via contract with outsiders
ii. The Coasean Firm
1. Resources are allocated to their highest and best use not in response to governmental orders or other communicated commands, but, as if by an invisible hand through the separate, self-interested choices of all producers and consumers
iii. The Principal-Agent Model
1. Shareholders own a firm, the firm is the shareholders agents and are merely delegating control to the board of directors, who delegates control to the officers (CEO, CFO, COO, etc.)
2. Why don’t shareholders own the firm themselves? Why delegate control?
a. Transaction Costs – Completely inefficient, take too long for day to day
b. Operating choices are difficult to make day to day
c. People don’t necessarily have an incentive if they have minimal shares in the firm
i. Collective action
ii. Rationality
d. Maybe this would work with a small, ten shareholder company, etc.
e. Agency Costs: Conflicts of interests between the principals desires and the agents desires
iv. The firm as Nexus of Contracts
1. The firm is described as a nexus of contracts between the various claimants to a share of the gross profits generated by the business.
2. This method involves both contract relationships and employees, etc.
3. This model believes The firm is nothing but a series of explicit and implicit contracts between all the corporate constituencies
a. Includes shareholders, suppliers, laborers, customers, directors and officers, local community, etc.
4. Problems
a. One problem is that in most instances there aren’t contracts (implicit)
i. Therefore, we engage in hypothetical bargaining
1. (1) The goal is to maximize the value of the firm (efficiency);
2. (2) Shareholders are the principal residual claimant to this value (they get paid last – they get what’s leftover)
a. laborers get first, creditors get first, etc.
3. Conc: Shareholder’s goal is to maximize residual profit
b. Employees don’t worry about insuring the maximum value of the firm, they worry about cash flow, and those things that get them paid
c. Shareholders are also the least able of all the constituencies to protect themselves adequately
ii. Sell shares
iii. Sell assets
iv. Become more profitable – retain earnings
d. Dividends
i. The payout of the company’s earning to the shareholders – board has this discretion of whether to give dividends, shareholders have no say
e. Other devices that keep management in check:
1. Product markets (competition)
2. You can get fired
3. The Board can be Removed
b. Sole Proprietorship v. Business Association
i. Sole Proprietorship means a sole owner carries out business practice
ii. Business associations are more than one owners and are usually organized as a partnership, a corporation, or a limited liability company.
II. Organizing the firm: Selecting a Value Maximizing Governance Structure
a. Business Planning: The Role of the Corporate Lawyer
i. The lawyer is a planner of the business
ii. Important to recognize that firms like private settlement of disputes over litigation
This is more efficient and more in line with the pre-dispute expectations of the firm
