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January 31, 2005

Shareholders vs. Directors as Owners of the Firm; Bainbridge

From what Professor Thomas Smith says, Professor Bainbridge's UCLA conference on corporate law was a great success, with interesting papers and a crowd of interesting and diverse people like Hart and Presser. Why wasn't I invited? (maybe because I've never written a paper on corporate law and don't even have any related papers in progress.) But I can see some of the papers at ALEA in New York in May, most likely.

In his blog Bainbridge says:...

... Lynn Stout’s presentation forcefully makes the case for what she and I have taken to calling "director primacy": i.e., the idea that the corporation is a vehicle by which directors hire factors of production and the corollary proposition that shareholders have only the very limited set of control of rights for which they have bargained. ...

The other axis along which the shareholder primacy debate plays out relates to the ends of corporate governance. What is the decisionmaking norm that guides corporate governance? At one end of that axis lie folks like myself who believe that Dodge v. Ford Motor Co. meant what it said; namely, that the end of corporate governance is shareholder wealth and that the discretion of directors must be exercised towards that end.

(A blogging note: It would be nice if Bainbridge (and Reynolds, and others) had Weblog RA's. The RA would be told to scan the blog several times a day and links intelligently. In the post above, the RA would add links to Stout's paper, Bainbridge's paper, and Dodge v. Ford.)

I see a problem, so obvious that no doubt Bainbridge's journal articles deal with it: if the corporation is the directors', not the shareholders', why should the directors maximize shareholder wealth rather than their own wealth? I suppose the answer is that what Bainbridge means is that the deal between shareholders and directors is that the directors will act like trustees, maximizing shareholder wealth, but as the directors, not the shareholders, see fit. That's fine-- it's like the idea of republican instead of democratic government (small r and d), with the elected officials doing what they believe is right rather than what they believe the voters want. Burke, I think, took that view in a piece titeld something like "A Letter to the Electors of Bristol".

That is different, though, from the notion that the directors simply hire all the factors of production for their own benefit, including hiring capital from shareholders. If that were so, then the directors would be residual claimants. They would have to reward shareholders enough to make them buy risky shares, but if the corporation were unusually well run, well enough to have extraordinary profits, the directors would keep the excess.

Now I am starting to think that maybe that notion is correct, though. It looks like it would lead to efficient production. And it might fit reality-- with the directors being pretty safe from litigation, even if they self-deal or pay excesssive managerial salaries, so long as the shareholders do OK and are kept pretty happy. I'd have to do a formal model, I think, to figure it out.

Posted by erasmuse at January 31, 2005 02:10 PM

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