BUSINESS ORGANIZATIONS
LAMBERT
SPRING 2014
INTRODUCTION: The Nature of the Firm; the Corporate Lawyer as “Transaction Cost Engineer”
I. Introductory Comments & Terms
a. Greed is good; it’s right; it works.
b. What is capitalism?
i. Capitalism is an economic system that’s about allocating the productive resources of society with no plan.
ii. In a capitalist society, the leaders of the society don’t dictate where the productive resources go; the resources end up in the hands of those who value them the most.
iii. What’s at the opposite end of the spectrum?
1. Some type of centralized planning
2. Communism/Socialism
a. Best example is the Soviet Union, where the economy was centrally planned.
b. They put in place 13 5-year plans (some of which did not last 5 years), and people were dictating where the resources went.
iv. Why is capitalism better than centralized planning?
1. Central planners might confront a knowledge problem.
2. Because of this, socialism is destined to fail (& face problems with things like shortages and surpluses).
II. What is the fundamental economic problem society faces, and how is it generally solved?
a. In trying to construct a rational economic order, the problem would be simply one of logic if we possessed all the relevant information, but the problem is that the “data” from which the economic calculus starts is not “given” to any one person.
b. The problem is not one of how to allocate given resources; it’s a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know (i.e., a problem of the utilization of knowledge that is not given to anyone in its totality).
c. The knowledge you need to have to know what is the best and most productive use of resources is dispersed throughout society. (At the very least, social planners don’t know what everyone else prefers.)
d. Our alternative to the centralized planner is to leave decisions to the man on the spot.
e. However, we still have a problem, as the man on the spot needs to know what is going on in the outside world.
f. We solve this knowledge gap in a few ways:
i. Price system – Supply & demand (which determine cost); System ultimately tells us where supply stands relative to demand
1. If there’s a shortage, demand is high relative to supply, and price tends to rise. When the price rises, consumers substitute away from that thing, and producers start to make more.
2. If there’s a surplus, demand is low relative to supply, and the price tends to drop. Consumers substitute toward that thing, and producers stop producing so much.
ii. Knowledge of what’s going on in the outside world
1. Articles about what’s going on
2. Price = marvel
a. Incorporates all of the information, as people have already taken these factors into account in determining price
b. Tells people exactly what they need to know about resource allocation w/o having to give them any other information
III. Why do business organizations (firms) emerge?
a. What would you do if you wanted to start a business?
i. Get capital equipment, labor, and supplies
ii. You’d typically hire people via long-term Ks (although Hayek would have you go to the unemployment office on a daily basis to buy your labor)
iii. You buy your supplies via long-term supply Ks (instead of going to Wal-Mart every day and buying exactly what you need every day)
b. What is a “firm” (i.e., business organization)?
i. Firm = organization where price mechanism is superseded and you have a “boss man” saying where the resources need to go.
ii. Economically
1. Distinguishing characteristic is that is supersedes the price mechanism
2. Firms have a centralized planner that allocates resources to go to a certain place.
3. “Firms are basically islands of socialism floating around in the beautiful sea of capitalism.”
iii. Legally
1. Elaborate nexus of contracts
2. Relates to ways to get money
a. Could borrow
b. Could use equity financing – people provide money and, instead of being given a promise of repayment, are given a promise to share in the profits of the firm
3. At the end of the day, we end up with an operation where all the people who have an interest in the organization are connected via contract.
c. Why do we have firms?
i. There’s a transaction cost of using the price mechanism daily and entering into each individual K based on that daily price.
ii. Using the market to allocate costs is costly – those costs get too high.
iii. Coase says you can contrast two ways of allocating resources:
1. Resources flowing from the market
a. Con = transaction costs
2. Resources directed by managerial fiat
a. Con = allocative inefficiency (i.e., some resources will be misallocated)
b. Con = agency costs (losses occur whenever principal/owner hires somebody else to work for her)
i. A sad, but true, fact is that people are lazy.
ii. Can be grouped into two forms of costs
1. Negligence
2. Opportunism (taking goods for yourself)
iii. Bodies of law were developed for these problems
1. Duty of care
2. Duty of loyalty
IV. How could a lawyer “add value” in organizing a business?
a. Law provides off-the rack Ks that say people who provide money in certain types of organizations are entitled to certain things
b. Lawyers can organize business organizations by type:
i. Sole proprietorships (The law of agency)
ii. General partnerships
iii. Limited partnerships
iv. Corporations
v. Limited liability companies
c. We provide value in these ways:
i. Being a cost engineer & figuring out ways to use Ks to reduce transactional costs
ii. Being a tailor & tailoring these nexuses of Ks to suit the needs of our clients
AGENCY
I. Generally
a. Definitions
i. Agency = fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act
1. Must be an agreement, but not necessarily a K
car.
iii. Cargill: K case (not tort): Cargill provides credit to Warren, who buys seed from farmers and promises to pay them. When Warren goes bankrupt, farmers sue Cargill.
1. Note: Unlike Doty, this is a contract case – not a tort case.
2. Here, the court focuses on the control element above all others and basically infers an agency relationship.
a. Cargill manifested consent.
b. Warrant acted “on Cargill’s behalf.”
c. Cargill exhibited de facto control over Warren’s actions.
3. Cargill argued that this was a creditor/debtor relationship.
a. RS: “The point at which the creditor becomes a principal is that at which he assumes de facto control over the commercial of his debtor.”
b. In other words, under the Restatement approach, it’s okay for a creditor to just exercise a veto power over certain decisions by the borrower. When the creditor gets so involved in the business of the debtor that he assumes control over the conduct of the debtor, a principal/agent relationship is created.
4. Cargill also argued that this was a BUYER/SUPPLIER relationship.
a. Overarching test is basically whether the buyer is acting primarily for the supplier, and you can look at the factors to decide.
b. Restatement 2d § 14K – Factors indicating that one is a supplier, rather than an agent (do not need all, weighing test):
i. That he is to receive a fixed price for the property irrespective of the price paid by him (most important)
ii. That he acts in his own name and receives title to the property which he thereafter is to transfer (basically focuses on where the title goes – if it stops with the middle man, it looks like B/S; if it bypasses the middle man, it looks like P/A)
iii. That he has an independent business in buying and selling similar property.
c. How did this cut here?
i. Even though the first two factors weighed in favor of this being only a buyer-supplier relationship, the court found that the third factor could not be met because of the degree of control.
ii. Court misapplied the Restatement in saying that the third factor must be proven, as the Restatement does not include the word “and.” These are factors; not elements.
5. In this case, we essentially have a debtor/creditor relationship that’s also a buyer/supplier relationship where the creditor-supplier is also exercising a tremendous amount of control over the debtor-buyer.
a. Because of this control, it becomes a P/A relationship.
b. Cargill will basically get any benefits Warren derives.
c. Master/Servant
