The following entry appeared as part of Harvard Law SchoolForum on Corporate Governance and Financial Regulation
Editor’s Note: The following post comes to us from Margaret M. Blair, Professor of Law at Vanderbilt University.
In the paper, Corporate Law and the Team Production Problem, which was recently made publicly available on SSRN, I discuss an alternative framework to the principal-agent model for understanding corporate law. For much of the last three decades, the dominant perspective in corporate law scholarship and policy debates about corporate governance has adopted the view that the sole purpose of the corporation is maximizing share value for corporate shareholders. But the corporate scandals of 2001 and 2002, followed by the disastrous performance of financial markets in 2007-2009, have left many observers uneasy about this prescription. Prominent advocates of shareholder primacy such as Michael Jensen, Jack Welch, and Harvard’s Lucian Bebchuk have backed away from the idea that maximizing share value always and everywhere has the effect of maximizing the total social value of the firm. Shareholders, they concede, may often have incentives to take on too much risk, thereby increasing the share of firm value they capture by imposing costs on creditors, employees, taxpayers, and the economy as a whole.
In response to the problems with shareholder primacy revealed by corporate and financial market crises in recent years, some scholars and practitioners have considered the “team production” framework for understanding the social and economic role of corporations and corporate law (Blair and Stout, 1999) as a viable alternative. Whereas the principal-agent framework provided a strong justification for the focus on share value, the team production framework can be seen as a generalization of the principal-agent problem that is symmetric: all of the participants in a common enterprise have reasons to want all of the other participants to cooperate fully. A team production analysis thus starts with a broader assumption that all of the participants hope to benefit from their involvement in the corporate enterprise, and that all have an interest in finding a governance arrangement that is effective at eliciting support and cooperation from all of the participants whose contributions are important to the success of the joint enterprise. A team production-based analysis of corporate law then points to a number of features of corporate law and the corporate form that do not seem consistent with shareholder primacy but that may provide a workable solution to the team production problem.
Scholars have identified six attributes available under corporate law around the world that are typically not available for common law partnerships (though some of these attributes are now available through various hybrid forms of organization) (Armour, Hansmann & Kraakman, 2009). These are legal personality or separate existence; limited liability; transferable shares; delegated management under a board structure; investor “ownership”; and indefinite existence. All of these attributes, however, are problematic under a shareholder primacy analysis. Separate existence creates a significant barrier to shareholders if they want to get their investment back out of a corporation. Limited liability protects shareholders from bearing responsibility for a corporation’s actions – hardly a characteristic that we would normally associate with ownership. Transferable shares complicate the question of who the “principal” would be in a principal-agent analysis of corporate law. Management by or under a board of directors makes it much harder for shareholders to control what happens in the corporation; investor “ownership” is a feature that numerous scholars and legal researchers have asserted applies to corporations, but it is a misnomer, since neither shareholders nor other investors have the full panoply of rights with respect to the corporation or its property that apply to “owners” in other contexts; and indefinite existence contributes to a divergence between what is good for the corporation and what might be good for shareholders.
Yet all of these features can be seen to have an important function under a team production analysis. Separate existence provides a mechanism by which assets used by the team can all be owned by the same entity, and makes it clear that no one team member or class of team members (such as shareholders) directly own those assets. Limited liability for shareholders follows naturally from separate existence, and is consistent with team production – if the shareholders don’t own the assets, and don’t control their use, then it does not makes sense to make them liable for the misuse of the assets. Shares can be transferrable because the contribution of shareholders to the team enterprise (money) is completely fungible, so the identity of the shareholders is normally a matter of complete indifference to the other team members. The delegation of management to a board helps to solve the central problem of team production because it assures that no single team member can unilaterally usurp control and hold up all the other team members (Blair and Stout, 1999). Investor “ownership,” as noted above, is actually a misnomer. Shareholders own their shares, of course, just as employees may own their pension claims and bondholders own their bonds. But shareholders have very limited voting rights, and almost no rights to control the day to day operations of the corporations. This is highly problematic for shareholder primacy advocates (e.g., Bebchuk, 2005; Bebchuk, 2007), but is exactly what we would expect under a team production analysis. Finally, corporations have indefinite existence, which facilitates the accumulation of assets in the firm that are specialized to the team enterprise, and that cannot be pulled out by any individual team members. As the problems resulting from single-minded focus on maximizing share value have become more apparent, the team production theory alternative may be seen as increasingly relevant.
The full paper is available for download here.