Markets & Democracy: The Illegitimacy of Corporate Law

Corporate law does not conform to ordinary democratic norms. Unlike human citizens, corporations may decide which law will govern their most fundamental acts of self-governance. The corporate law corporation choose in turn influences the corporate goals and decision-making processes that determine what the corporation looks for in corporate law in a reflexive system independent of ordinary political processes. This system seems on its face to violate the most fundamental principle of popular sovereignty–all non-Delaware citizens of the United States are excluded from even formal participation in the process of determining American corporate law, and even Delaware citizens are reduced to a largely formalistic ratification role of results coerced, to a large extent, by the market for corporate control and the internal norms of a self-replicating system of law that has escaped from political control. Corporate law scholars have devoted many pages to debating whether the surrender of corporate law to a market for corporate reincorporation generates substantively good or bad results, but there has been virtually no discussion of whether this process can be squared with the American commitment to self-governance. This Article aims to address that latter issue–with its obvious implications for other areas in which we, consciously or unconsciously, decide to subordinate politics to markets or vice versa

The Dividend Problem

Everyone knows that shareholders receive dividends because they are entitled to the residual returns of a public corporation. Everyone is wrong. Using the familiar economic model of the firm, I show that shareholders have no special claim on corporate economic returns. No one has an entitlement to rents in a capitalist system. Shareholders, the purely fungible providers of a purely fungible commodity and a sunk cost, are particularly unlikely to be able to command a share of economic profits or, indeed, any return at all. Shareholders do win much of the corporate surplus. But this is not by market right or moral entitlement. Rather, it is the result of a (possibly temporary) ideological victory in a political battle over economic rents. Surprisingly, since corporate law often assumes a conflict between shareholders and top management, shareholder gains flow from the usefulness of the share-centered ideologies in justifying a tremendous shift of corporate wealth from employees to top managers. Burgeoning CEO salaries are part of the same phenomenon as high shareholder returns, not in opposition to it. Taking the political nature of the corporation seriously will lead to a series of new and important questions. Are current distributions of corporate wealth justifiable, or should corporate governance treat lower-paid employees as citizens instead of subjects? Why should only one side in a political conflict have the vote, and why per dollar instead of per person? Given undemocratic internal corporate politics, are current levels of deference to corporate autonomy justifiable

The Semi-Sovereign Corporation

For at least a generation, corporate law scholars have worked within a paradigm of the corporation as a nexus of contracts, using metaphors drawn from contract, property, agency and trust to describe the relationships between shareholders and the firm as something like those of strangers in a market. But historically, corporations were understood to be political organizations much like a miniature state or sovereign. The political view emphasizes that the participants in a firm include more than the public shareholders, that they have relationships with each other that extend beyond the momentary contact of strangers in a spot-market, and most important, that the firm is a self-governing entity for many important purposes. Naturally, it also foregrounds the important issue of how corporations make the decisions they make and why only certain role-holders are enfranchised. In this essay, I begin the process of resurrecting the memory of the semi-sovereign corporation. By examining the history of early corporations in the early colonial enterprises, I focus on the historical connection, now lost, between our business corporations and our municipal, governmental, ones

Are Shareholders Entitled to the Residual?

Everyone knows that shareholders are entitled to the residual returns of a public corporation. Everyone is wrong. Using the familiar economic model of the firm, I show that shareholders have no special claim on a corporation’s economic returns. No one has an entitlement to economic rents in a capitalist system. Shareholders, the purely fungible providers of a purely fungible commodity, are particularly unlikely to be able to command a share of economic profits. Indeed, since the contribution of shareholders to the firm is a sunk cost, in a competitive market shareholders are unlikely to earn any return at all. Accordingly, market-based analyses of the firm should conclude that shareholder returns result from a market distortion. The implications are clear: shareholders win much of the corporate surplus not by market right or moral entitlement, but due to a (possibly temporary) ideological victory in a political battle over economic rents. Surprisingly, since corporate law often assumes a conflict between shareholders and top management, shareholder gains are more likely the result of the usefulness of the share-centered ideologies in justifying a tremendous shift of corporate wealth from employees to an alliance of top managers and shareholders. Standard accounts conceal the struggles over corporate surplus and the weakness of shareholder claims to appropriate it. Taking the political nature of the corporation seriously, in contrast, will lead to a series of new and important questions. Why should only one side in a political conflict have the vote, and why should a democracy allocate votes per dollar instead of per person

Corporate Governance and Bankruptcy

Ordinary corporate law invests enormous authority in corporate leaders, largely without accountability either to those they govern or to the judiciary, in defiance of much of what we know about effective governance procedure. Instead, we rely on the markets in which the corporation participates as the primary check on incumbent officials. Regardless of whether relying on markets is sufficient in the ordinary course, corporate insolvency is the markets’ verdict that incumbent management has failed. Accordingly, in bankruptcy and insolvency more generally, the law ought to abandon its ordinary deference to the corporate powers that be and instead impose standard good governance rules. Failed incumbents should be replaced and those governed should have political voice, not merely market exit rights

Person, State, or Not: The Place of Business Corporations in Our Constitutional Order

Business corporations are critical institutions in our democratic republican, market-based, economic order. The United States Constitution, however, is completely silent as to their status in our system. The Supreme Court has filled this silence by repeatedly granting corporations rights against the citizenry and its elected representatives. Instead, we ought to view business corporations, like municipal corporations, as governance structures created by We the People to promote our general Welfare. On this social contract view, corporations should have the constitutional rights specified in the text: none. Instead, we should be debating which rights of citizens against governmental agencies should also apply to these state-like governance institutions

Partnership, Democracy, and Self-Rule in Jewish Law

Liberal political theory has long relied on a metaphor of contract: autonomous adults coming together to agree, by unanimous consent, on the basic structure of a just society. But contract is a strange metaphor with which to explain society. Contract law is based on a morality of strangers acting at arms-length. In contrast, decent societies and the governments they set for themselves must be based on a commitment of mutual responsibility. What makes us fellow citizens—fellows of any variety—is accepting that we are all in this together. Jewish legal and midrashic traditions can be a useful corrective to the atomistic metaphors underlying most liberal political theory. The Jewish tradition has never had the luxury of imagining self-sufficiency, that government itself is the primary source of unjust power, or that individuals could be free in a state of nature. We too can no longer ignore that a solitary human being is a dead human being, that we need government to make spaces in which we can be free from want, resist oppression by non-governmental power, reverse the destruction of the natural commons on which we depend, and engage in the communal activities that make life meaningful. The partnership metaphor, I argue, can make visible the mutual concern and collective effort that must characterize decent and just governments in an age of economic challenges and ecological crises. The goal of liberalism should not be individual self-determination but the freedom to live together in peace, prosperity and justice

Looting: The Puzzle of Private Equity

In the last generation, executives have engaged in a sort of moral arbitrage, replacing fiduciary with market norms to justify allocating to themselves an ever-increasing share of the corporate pie. The private equity sector has taken this process to its logical conclusion; it has completely abandoned the notion that corporate office brings with it obligations. Instead, it openly celebrates self-enrichment over institution building or public service. Unfortunately, corruption is just as corrosive in the private sector as in the public sector. Office-holders who seek personal enrichment will nearly always find looting more profitable than construction and betraying co-adventurers more lucrative than genuine commitments. The essay proceeds as follows. In Part I, I explain the normative duality of the firm and its relationship to classic understandings of corruption. Part II summarizes the rhetorical devices by which corporate executives have arbitraged between the two spheres in order to escape the bonds of professional and fiduciary duties. Part III applies this analysis to the private equity world: by re-characterizing managers as shareholders, private equity can authorize previously unknown levels of looting. Part IV explores the theoretical and practical crises that result. Private equity accentuates the agency-cost problem by adding another layer of managers with unprecedentedly high pay and increased discretion. Simultaneously, and more importantly for the economy as a whole, it heightens the paradox of the managerial role in a shareholder-centered theory of the firm. Successful corporations require trust: neither employees nor passive investors fully negotiate ex ante contracts. Modem conceptions of the share-centered corporation threaten that trust, by encouraging managers to breach implicit commitments to employees whenever expedient to increase shareholder returns. Contractual understandings of managerial roles, in turn, justify managers treating shareholders with equal cynicism. Private equity heightens the stakes. On the one hand, high-powered incentive pay promises executives extreme payoffs from successful exploitation of employees or other contracting parties. On the other hand, the private equity system offers ideological justification for self-interested looting by freeing managers from any residual sense of obligation to the firm itself, its employees or passive investors. Other corporate participants are likely to respond in the only effective way: by mistrust and withdrawal. The overall effect likely will be to reduce American competitiveness and economic growth prospects. In short, on a practical level, the success of private equity threatens market collapse. On a theoretical level, the success of private equity delivers the final blow to whatever is left of the efficient market paradigm