Document Type

Article

Publication Date

2005

Center/Program

Center for Contract and Economic Organization

Center/Program

Center for Law and Economic Studies

Abstract

I am delighted to participate in taking up Professor William Klein's suggestion that we could learn something by attempting a functional typology of corporation law. As a starting point, any typology must be animated by an underlying theory whose terms dictate the lines the typology draws. I want to focus my contribution at the level of the theory that might animate the architecture of this grid. To see what I mean by this, think of the Sesame Street version of Edward Levi's classic, An Introduction to Legal Reasoning.1 The character points at a board on which there are pictures of a number of objects and sings: "One of these things is not like the other; one of these things just doesn't belong."2 The idea is to teach the children (and law students) to distinguish between categories based on a principle. My concern here is with the principle that might allow us to choose among Bill Klein's litany of potential criteria of good corporate law.

In particular, I will focus on the separation theorem, which states the implications of complete capital markets on shareholder preferences concerning corporate investment policy. My proposition is that the presence of markets in the list of characteristics that determine equity value makes a radical difference in the function played by corporate law. In these circumstances the criteria for good corporate law are limited to a single overriding goal: facilitating the maximization of shareholder wealth. I will illustrate the usefulness of a unicriterion view of corporate law by briefly taking up two familiar issues that span the corporate law domain: the idea of a stakeholder-oriented board of directors in public corporations and the role of the courts in enforcing the reasonable expectations of private corporation shareholders.

This emphasis on the link between markets, asset pricing, and legal institutions has been a familiar theme in my work. For example, I have argued that business lawyers function to make up for market failures in asset pricing.3 Similarly, Reinier Kraakman and I have stressed that familiar institutions operate to alleviate failures in the information market and thereby operate to support price efficiency.4 I am convinced that the benefit of working out this interaction between the structure of institutions, including here the structure of corporation law,5 and the efficiency and completeness of related markets, results in a good deal more than what my friend Bob Mnookin refers to as "cute" theory-that is, theory which appears elegant at first glance, but whose simplicity results not from deep insight but from surface facility.

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