Document Type

Article

Publication Date

1989

Center/Program

Center for Contract and Economic Organization

Center/Program

Center on Corporate Governance

Abstract

A half-filled glass of water can be described as either half full or half empty. The structure of American corporate law-partly enabling, partly mandatory in character-can be viewed in much the same way. Some commentators see American corporate law as primarily composed of mandatory rules that the shareholders themselves cannot waive or modify.1 In their view, this mandatory component compensates both for the absence of true bargaining among the parties and for the inevitable divergence of interests between the principals (the shareholders) and their agents (the managers and directors). Conversely, other commentators, to whom this Article will refer as "contractarians," see corporate law as primarily composed of waivable "default rules," which the law provides as a model form contract in order to reduce the transaction costs of contracting.2 Under this view, theparties are free to "opt out" of these "off-the-rack" rules if they wish to strike a different bargain that is more individually tailored to their specific circumstances.3

Contractarians thus view corporate law as simply a modest extension of contract law, while their opponents regard the analogy between contract and corporate law as descriptively inaccurate. Both sides reach their respective positions because of a shared assumption that mandatory legal rules are "anticontractarian"; that is, the description of the corporation as a contract (or as a "nexus of contracts") implies for both sides that the law should permit shareholders to write or amend the corporate contract in virtually any way they see fit. Because the anticontractarians believe that shareholders should not be permitted to opt out from the mandatory core of corporate law, they tend also to resist the contract law analogy. As a result, they have tended to overlook the degree to which modem contract law itself contains important mandatory elements.

Once the debate between the contractarians and their opponents has been joined in this fashion, its focus has generally shifted from law to economics and, more specifically, to the question of whether market forces provide an adequate substitute for actual bargaining. Although the issue of how well the market prices corporate governance terms can certainly be sensibly debated,4 an exclusive focus on economics ignores an important feature common to all forms of long-term relational contracts: namely, that courts have invariably played an active and indispensable role in monitoring and interpreting such agreements.5 Indeed, the feasibility of such contracting probably depends upon the parties' ability to rely upon the courts to play such a role. In this light, analogizing the corporation to a long-term contract may suggest not that the mandatory features of American corporate law are vestigial remnants of an earlier era that was hostile to private ordering, but rather that these provisions are analogous to similar legal rules that restrict opportunism in other areas of complex, long-term contracting. Put simply, the more closely one looks at long-term contracting, the more one realizes that judicial involvement is not an aberration but an integral part of such contracting.

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