Business Organizations Outline

Business Organizations
Royce Barondes

Economic & Legal Aspects of the Firm
I. Definition of a firm
a. The Coasean firm: Firms v. Markets
i. The “firm” is the set of relations that arise when resources are allocated by the entrepreneur via commands to her employees
1. As opposed to the set of relations that arise when an entrepreneur allocates resources via K w/ outsiders (outsiders being the “market”)
b. The firm as a nexus of K’s
i. Principal-agent theorists, however, emphasize the K nature of a firm: it is a nexus of Ks between the various claimants to a share of the gross profits generated by the business
c. Sole proprietorship v. business association
i. Sole proprietorship: ownership responsibilities are invested in one individual
ii. Business association: the firm operates under some type of joint ownership
II. Why do firms exist?
a. Economic reasons
i. Firms aid in maximizing efficiency (they reduce the amount of contracting that is necessary to conduct operations) by providing a schematic through which parties can more readily adapt, f/ex, to changing expectations (specification at the time of contracting is often difficult)
1. Discrete contracting (rigid) and relational contracting (less rigid) both specify the expectations of the parties through express contractual provision
b. Legal reasons
i. Limited or less liability
c. Disadvantages (transaction cost factors)
i. Bounded rationality
1. There are too many factors to be considered at the time of contracting to create a K that will perfectly match the long-term expectations of the parties
a. This is a good argument for relational contracting as opposed to rigid contracting, but even relational contracting cannot eliminate every risk
i. Valuation
1. A market generates valuation information; however, in a firm, the valuation must be estimated
ii. Agency costs
1. Opportunism
a. Someone is more interested in promoting his own interests as opposed to that of the employer
2. Monitoring
a. Money and effort must be expended to keep employees from being opportunistic
III. What factors influence private ordering (contracting)?
a. State-provided governance structures
i. Off-the-rack rules that provide entrepreneurs with a framework for relational contracting
b. Risk & return
i. In comparing investment options, entrepreneurs estimate the “expected return” for investments that have a range of possible outcomes (as opposed to one possible outcome)
ii. The expected return for these investments is estimated by first multiplying each possible return by its probability, and then summing these products
1. If an investment has a 90% chance of paying $0 and a 10% chance of paying $20,000, how much will someone pay for the investment?
a. Do the math:
i. 90% x $0 = $0
ii. 10% x $20,000 = $2,000
$2,000
2. Also, consider the risk factors
a. If you are risk neutral, you would pay around $2,000
b. If you are risk averse, you would be willing only to pay less than $2,000
c. If you are risk preferring, you would be willing to pay more than $2,000
c. Non-judicial mechanisms that reinforce private ordering
i. The governance role of markets
1. The product market
2. The capital market
3. The national securities market
4. The labor markets (including the market for managerial services)
5. The market for corporate control (added by Royce)
a. Director’s of a Board are elected by share-holders and Director’s appoint the officers that perform day-to-day management
i. If the management is doing a bad job, it will be evident
ii. If someone can gain a substantial hold of the stock, then the “insurgents” can overtake the firm and oust the current officers
iii. This only works if there is a market for the company stock

Agency Law
I. Definition of agency law
a. Generally
i. Agency law governs the relationship between two persons
1. Rest. of Agency 1, Definitions
a. Agency is the fiduciary relation which results from
i. The manifestation of consent by one person to another that the other shall
1. Act on his behalf,
2. Subject to his control, and
3. Consent by the other to so act
II. Fiduciary limits on an agent’s right of action
a. Fiduciary duty is a contractual device supplied to the parties by the state; it substitutes for an express contractual specification of exactly what an agent may or may not do on behalf of the principal
b. It obliges the agent to act in the best interests of the principal and to refrain from self-interested behavior not specifically allowed by the employment K
c. Elements considered in determining w/o/n an agency relationship exists
i. Control
1. How much control did the putative principal exercise over the putative agent’s decision-making
ii. Benefit
1. Was the putative agent acting for the putative principal’s benefit or for personal gain?
d. Carrier (p. 2, S-A)
i. Plumber-customer relationship
1. There are two possibilities for how this relationship can be characterized
a. Agency
i. The plumber is the agent for the purposes of the given situation
b. Non-agency (parties are independent contracting entities)
i. This is a matter of contract law
1. The consumer assigns her rights in regards to any claim upon the manufacturer to the plumber
2. Analysis involves two components:
a. Has an agency relationship been created?
i. An agency relationship is created when
1. A principal gives authority to another to act on his behalf
2. The agent consents to do so
a. The granting of authority and consent need not be written but can be implied from the parties’ conduct
b. If there is an agency relationship, what are the rights and duties of the parties?
i. Rest. Agency 377, Contractual Duties
1. Under ordinary circumstances, the promise to at as an agent is interpreted as being a promise only to make reasonable efforts to accomplish the directed result
a. The duties of an agent toward his principal are always to be determined by the scope of the duty conferred
2. The degree of skill required by an agent in pursuit of the principal’s objective is limited to the level of competence which is common among those engaged in like businesses or pursuits
3. An agent cannot be held liable to the principal simply b/c he failed to procure for him something to which the latter is entitled
ii. Rest. Agency 14, Control by the principal
1. A principal has the right to control the conduct of the agent w/ respect to matters entrusted to him
a. Even if the principal agrees not to exercise this right, the agent is still subject to a duty not to act contrary to the principal’s directions (Rest. Agency 33, General principle of interpretation)
b. The principal has the power to revoke the agent’s authority, although this would constitute a breach of K (Rest. Agency 118, Revocation or Renunciation)
c. There are many relations in which one acts for the benefit of another which do not constitute an agency relationship b/c there is no control by the beneficiary
i. Executors
ii. Guardians
iii. Receivers
iv. Directors
e. Hunter Mining Labs I (p. 6, S-A)
i. Does the manufacture of products create a P-A relationship between the manufacturer and the distributor?
1. Factor’s considered.
a. Control
i. Frequency of control
1. “Premises must be kept appropriate”
2. “Monthly reports must be submitted”
3. “Contract is terminable”
2. “These types of controls, typical in manufacturer/distributor agreements, protect the manufacturer’s good will and integrity. They are not the types of control that create a q of fact regarding agency. ONLY WHEN A MANUFACTURER CONTROLS THE DAY TO DAY OR OPERATIVE DETAILS OF THE DEALER’S BUSINESS IS AN AGENCY POTENTIALLY CREATED”
ii. Rest. Agency 2, Master; Servant; Independent Contractor
1. P-A v. Master-Servant
a. A master-servant relationship is created when the principal has control over the physical conduct of the agent
2. Independent contractor
a. A person who Ks with another to do something for him but who is not controlled by the other in respect to his physical conduct
i. This may or may not constitute an agency relationship
iii. Rest. Agency 220, Definition of Servant
1. A person employed to perform services in the affairs of another and who is subject to the control of the employer in regards to the physical conduct involved in the performance of services
a. Servant v. Independent Contractor, factors considered
i. The extent of control
1. As evidenced by the agreement
ii. The distinctiveness of the occupation or position
iii. W/o/n, in the locality, the particular type of work is usually done by a servant or an unsupervised specialist
iv. The skilled required
v. W/o/n the employer supplies the instrumentalities, tools, place of work
vi. The length of time of employment
vii. The method of payment (by time or by the job)
viii. W/o/n the work is part of the regular business of the employer
ix. What the parties believe the relationship to be
x. W/o/n the employer is in business
f. Stanford, the DQ case (p. 8, S-A)
i. Is a franchise relationship an agent-principal relationship?
1. It depends…
a. Factors considered…
i. Control
1. Inspection of agent by the principal
2. Training of agent by the principal
3. Advertising requirement
4. Building specifications
ii. Benefit
1. Furtherance of the franchise trademark
2. Royalty payments
2. The ct rules that the franchise relationship does not create an agency relationship b/c the parties do not act on behalf or for the benefit of one another
a. But, this is clearly ridiculous: the higher ct doesn’t want to disturb the ruling of the lower ct
b. They state that the above factors could have given rise to the finding of an agency relationship
ii. Royce’s Final Observation
a. Ordinary market transactions are arrangements that sh