BO literature

Jensen & Meckling

• The firm is a “nexus of contracts” (legal fiction as the center of contracts; instead of everybody having contracts with everybody, everybody has a contract w/ the firm

• Agency problems (as principal & agents have differing interests) —> costs of agency

Coase

• there are costs of using the market (transaction costs) and costs of organizing a firm (organizational costs), which in turn determine what is best done inside and what is best done outside the firm

• If organizational costs > transaction cost —> no need for a firm

Alchian & Demsetz

• a firm is a way to organize team production

• Several individuals (inputs) contribute to joint output

• Metering problem: it is difficult to assess how much each individual contributed by looking simply at the

• The firm is a policing device created to solve the metering problem and make team production possible

• A firm is better than the market if its benefits (reduced shirking) are larger than its costs (hiring a manager)

• Monitor is incentivized to monitor as he is the RESIDUAL CLAIMANT of the firm (if firm does well, he profits)

Hart

• Contracts are INHERENTLY INCOMPLETE

• contracting always has a weaker and a stronger party —> the stronger party can hold up the weaker party as it has more bargaining power (i.e. it invests second)

• we resolve the HOLD-PROBLEM by giving the weaker party ownership of assets (i.e. property) —> ownership gives a party the residual control right —> they decide what to do with an asset where a contract does not stipulate a course of action (i.e. contract is incomplete)

  • FIRM IS A BUNDLE OF PHYSICAL ASSETS

Abatino, Dari-Mattiacci, and Perotti

• There was no corporation under agency law (at least not one in the private law sense)

  • No representation, limited liability, entity shielding, capital lock-in, or tradability of shares!

• Exception: the peculium

  • As slave was a thing (had no legal personality), he could enter into contracts with others in the owners’ names and bind the owners —> slave was given a peculium

    • The creditors could not seize anything more than what was in the peculium

Hansmann, Kraakman, & Squire

• Key features of legal personality (agency/representation, limited liability, entity shielding, capital lock-in, tradable shares)

• Paper discusses entity shielding; distinguished between

  • weak = company creditors have priority over personal creditors

  • strong = no liquidation, but person creditors can claim shareholders’ personal shares

  • complete = no liquidation protection + personal creditors have no claim whatsoever

Hansmann & Kraakman (asset partitioning)

• Paper discusses ASSET PARTITIONING (= separates the assets of the firm from those of its shareholders)

  • limited liability (defensive asset partitioning) = firm creditors cannot seize personal assets of shareholders

  • entity shielding (affirmative asset partitioning) = personal creditors cannot seize firm assets

• The role of organizational rules can be:

  • enabling = the law provides a set of default rules (thus, cannot be replicated through contracts) —> limited liability

  • essential = the rules can only be imposed by the law (thus, cannot be replicated through contracts) —> entity shielding

Dari-Mattiacci et al.

• Discuss the rise of capital lock-in: the corporation emerged out of the need to lock-in capital for the long-term

• VOC vs. EIC

• Importance of permanent capital for supporting long-term investments

  • Rise of the stock market as a way to provide liquidity (i.e. provides an exit for shareholders when a firm has capital lock-in)

• Capital lock-in arose in republics that had favorable political conditions (i.e. low risk of expropriation)

Kuran

• Discusses the development of the corporate form in the Middle East

• Islamic law traditionally only recognizes natural persons —> no legal personality of the corporation

• Catholic Church encouraged the founding of sub-groups within communities (e.g. monasteries, universities) —> led to the corporate form

• Islam unified tribes into a single collectivity (the Umma) —> no space left for autonomous sub-groups to form in the community

• Instead of partnerships, the Islamic world relied on the waqf = a pious foundation established for a purpose that was unchangeable (this foundation did not dissolve upon the death of its owners like a partnership did)

  • waqf had capital lock-in (owners could not withdraw capital invested for that specific purpose)

  • but, no legal personality of the waqf

Butler

• Discusses the move from ad hoc law for a single company to a general law for all companies (= move from special to general incorporation status)

• If corporate status is a special privilege, it can be sold —> States compete in the granting of corporate charters

• Keeping access to corporate status restricted is no longer profitable —> push towards general incorporation statutes

  • The corporation is now a freely available organizational form (i.e. general law)

Ayotte & Hansmann

• Discuss the bundling of contracts

• Firms are organized in different legal entities when it is advantageous to bundle together different contracts

  • The bundle of contracts may have more value together than their sum

    • Contracts should not be individually assignable! (even though owner may be incentivized to do that to get some opportunistic value out of it)

• Ex ante there is a problem with incentives to invest (if investments are non-contractible)

• Ex post there is a problem with opportunistic assignment (if contract characteristics are non-contractible)

  • If we want to solve hold-up problem, we grant assignability, but then we cause opportunism problem —> SOLUTION: BUNDLED ASSIGNABILITY!!!

Baird & Casey

• Discuss the notion of entity partitioning in bankruptcy procedures

• Entities go bankrupt

  • If firm is organized in one entity (all assets fall under that entity) —> automatic stay applies to that entity and assets cannot be withdrawn

  • If firm is organized in several entities (assets are accordingly also split across entities) —> automatic stay only applies to the one bankrupt entity & creditors with assets in other entities may freely withdraw them

• Withdrawal rights give a state-contingent residual control right, i.e. the right to grab the asset (the contingency being bankruptcy)

  • Withdrawal rights increase bargaining power

Rauterberg

• Focuses on asset partitioning between assets of the manager and assets of the entity

  • principal shielding = protection of the entity’s assets from the manager’s personal creditors

  • manager shielding = protection of the manager’s assets from the entity’s creditors

    • These two functions are embedded in proprietary rights which cannot be mimicked by contracts+ agency law is of fundamental importance(contrary to JM who stipulate law only plays a limited role)

      • Agency law plays an important role because it create principal and agent shielding!!!

Pargendler

• The focus of her paper is on regulatory partitioning (the organization and its shareholders have different attributes & are thus subject to different regulations)

• Asset partitioning —> veil piercing results in asset departitioning (uni-directional; in some cases (e.g. fraud), courts may reach the personal assets of controlling shareholders i.e. limited liability is undermined)

• Regulatory partitioning —> veil peeking results in regulatory departitioning (bi-directional; involves attributing some of the duties/rights of the shareholders to the firm; this is done to prevent avoiding regulations through the use of entities)

Hansmann & Pargendler

• entities should not focus on shareholders profit maximization, but rather on consumer welfare maximization (i.e. more consumer surplus)

• You do not want monopolistic pricing if your are both a shareholders & a consumer

  • With monopolistic pricing, the LOSS TO CONSUMERS IS GREATER THAN THE GAIN TO MONOPOLIES

• Remember the Adam and Eve example (Snake is selling the apple)!

• KEEPING OWNERSHIP AND CONSUMPTION ALIGNED

Iacobucci & Triantis

• What is the idea debt-to-equity ratio?

  • New firms financed by more equity (lower debt-to-equity ratio)

  • Old firms financed by more debt (higher debt-to-equity ratio)

• By splitting the firm into two separate entities, we can tailor the capital structure of those entities to reach an ideal one (when they are organized in one entity, we end up with something in between that does not work for either)

Haansmann & Kraakman (notice

• Why do we have only a limited list of proprietary rights (numerus clausus) while we can create virtually any contract we can think of (freedom of contract)?

• Two main characteristics of property rights: erga omnes (apply against everybody) & in rem (property is a right on assets, so it runs with the asset when it changes hands; the right follows the asset, not the person)

• Property serves as a way of solving conflicts with INCOMPATIBLE CONTRACTS!!!

• For a system of property rights to function properly, special institutions provide notice