Stefan Padfield is working on an interesting project, trying to sort out whether there is a theory of the corporation somewhere in the muddle that is the Supreme Court's campaign finance law. This a Herculean task, as it is one the court itself has mostly eschewed. As I noted when FCC v. AT&T came down:
The Citizens United decision last term attracted much criticism--not least from Con Law Professor-in Chief Obama--for holding that a corporation is a person and as such has certain constitutional rights. While I agreed with the holding, I was disturbed that the Chief Justice's majority opinion for the Supreme Court so obviously lacked a coherent theory of the nature of the corporation and, as such, also lacked a coherent theory of what legal rights the corporation possesses.
The utterly specious word games that drive this opinion simply confirm that Chief Justice Roberts has failed to articulate a plausible analytical framework for this important problem.
In his latest post, however, Prof Padfield prodded the bear by discussing the implications of director primacy for his project:
The aspect of my paper that I want to discuss this week is my assertion that the director primacy theory of the corporation is better aligned with real entity theory rather than the aggregate theory of the corporation—at least for the purposes of my paper. For the uninitiated, the aggregate theory of the corporation posits that the corporation is best understood as primarily an association of individuals. This is to be contrasted with artificial entity theory, which views the corporation as much more than simply an association of individuals—and traces that “much more” to advantages flowing from the state. Real entity theory, meanwhile, argues that the corporation should be understood as something independent of both the individuals that make it up and the state that created it. ...
My greatest obstacle in aligning director primacy theory with real entity theory is likely that Stephen Bainbridge, the leading proponent of the theory whom I quote above, disagrees. However, even Bainbridge has arguably acknowledged that there may be some limited role for viewing director primacy as an expression of real entity theory: “[T]o the limited extent to which the corporation is properly understood as a real entity, it is the board of directors that personifies the corporate entity” (quote from here).
To follow the argument below, please go read the whole thing. Now. Don't worry, I'll be here when you get back.
Okay, you're back.
My clearest statement of my own views on the nature of the corporation appeared in The Board of Directors as Nexus of Contracts. (You'll want to download it, but that can wait until we're done here.)
In it, I wrote that:
In one sense, the corporation is a nexus. To be sure, the traditional insistence that the firm is a real entity tends towards mindless formalism. Yet, perhaps some deference should be shown the corporation’s status as a legal person. Corporate constituents contract not with each other, but with the corporation. A bond indenture thus is a contract between the corporation and its creditors, an employment agreement is a contract between the corporation and its workers, and a collective bargaining agreement is a contract between the corporation and the union representing its workers. If the contract is breached on the corporate side, it will be the entity that is sued in most cases, rather than the individuals who decided not to perform. If the entity loses, damages typically will be paid out of its assets and earnings rather than out of those individuals’ pockets. To dismiss all of this as mere reification ignores the axiom that ideas have consequences.
If the connected contracts model is correct, and there is no nexus, employment contracts would cascade—looking rather like a standard hierarchical organization chart—with each employee contracting with his or her superior. (Debt contracts would be even more complex.) Such a cascade would be costly to assemble, if not impossible. Most corporate constituents lack any mechanism for communicating with other constituencies of the firm—let alone contracting with one another. Instead, each constituency contracts with a central nexus. Accordingly, constituencies must be (and are) linked to the nexus and not each other.
Although I perhaps could have been clearer (I am reminded of a quip attributed to Ronald Dworkin: "Once again, my critics have deliberately misunderstood me," but that seems inapt to the present discussion), this passage should not be understood as embracing either the real or artificial entity theory of the corporation.
The passage must be put in context. I am responding here to connected contracts model advanced by my friends Mitu Gulati, Bill Klein, and Eric Zolt:
Gulati, Klein, and Zolt contend that the firm is usefully understood as a set of connected contracts. Their model departs from contractarian orthodoxy, however, by denying the existence (and even the relevance) of the nexus concept. [Hence,] the firm described by Gulati, Klein, and Zolt neither is nor has a nexus. ...
In reply to which, I posed the question of whether "a model lacking the concept of a nexus [can] make useful predictions about the legal rules governing such firms?"
My answer to that question, obviously, is "no." In elaborating on that answer, I was trying to make the point that somewhere within the corporation there must be a nexus of contracts between factors of production. As I explained in the article:
In a more important sense, however, the corporation has a nexus. After all, to say that the firm is a nexus is to imply the existence of a core or kernel capable of contracting. But kernels do not contract—people do. In other words, it does us no good to avoid reifying the firm by reifying the nexus at the center of the firm. Hence, we must search for the person or persons who serve as the nexus of the set of contracts making up the firm….
If the corporation has a nexus, however, where is it located? The Delaware code, like the corporate law of every other state, gives us a clear answer: the corporation’s “business and affairs . . . shall be managed by or under the direction of the board of directors.” Put simply, the board is the nexus.
Accordingly, as I explained in the introduction to that article:
The director primacy model proposed herein is grounded in the prevailing law and economics conception of the firm; namely, the so-called nexus of contracts model.
Of course, I don't have a copyright on director primacy. Prof Padfield is free to reinterpret it as he sees fit. But I do want to take issue with his claim that:
Because director primacy theory at the very least has a lot in common with some versions of real entity theory, it seems better to locate it there than ignore it. For example, real entity theory has been described by Reuven Avi-Yonah as the theory which “represents the most congenial view to corporate management, because it shields management from undue interference from both shareholders and the state” (quote from here). That seems quite consistent with director primacy.
Just because two roads end up in the same place, doesn't mean that they are one and the same.
I argued in The Board of Directors as Nexus of Contracts (don't forget to download it) that the power of fiat within the corporation is an off-the-rack term of the standard form contract provided by corporate law:
... there is no necessary contradiction between a theory of the corporation characterized by command-and-control decision making and the contractarian model. The set of contracts making up the corporation consists in very large measure of implicit agreements, which by definition are both incomplete and unenforceable. Under conditions of uncertainty and complexity, the parties cannot execute a complete contract, so that many decisions must be left for later contractual rewrites imposed by fiat. It is precisely the nonenforceability of implicit corporate contracts that makes it possible for the central decisionmaker to rewrite them more or less freely. The parties to the corporate contract presumably accept this consequence of relying on implicit contracts because the resulting reduction in transaction costs benefits them all. It is thus possible to harmonize the Coasean and contractarian models without having to reject a theory of the firm in which the board of directors has the power to, say, direct the firm’s workers. Instead, the firm’s constituents voluntarily enter into a relationship in which they accept the board’s power of fiat, while reserving the right to disassociate from the firm.
Likewise, I argued that the business judgment rule--which shields most exercises of that power from judicial review--is another off-the-rack term of the corporate standard form contract.
To the extent that director primacy implies legal rules that shield "management from undue interference from both shareholders and the state," it therefore does so because those rules are majoritarian defaults provided by the law to facilitate private ordering. Not because the corporation is an entity.
Finally, I want to close by disclosing a personal foible. I have a very practical mind. Most abstract reasoning strikes me as metaphysical mumbo jumbo. When I look at the corporation, I thus find myself agreeing with Edward, First Baron Thurlow, who put it best: "Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?"
Apropos of which, in working on this post, I came across a truly wonderful old article: Felix S. Cohen, Transcendental Nonsense and the Functional Approach, 35 Colum. L. Rev. 809 (1935). As John Hasnas summarized the key part of the article (19 J.L. & Pol'y 55):
Felix Cohen began Transcendental Nonsense and the Functional Approach, perhaps the most entertaining law review article ever written, by describing a heaven of legal concepts in which could be found “all the logical instruments needed to manipulate and transform . . . legal concepts and thus to create and to solve the most beautiful of legal problems.” This heaven, which contained
a dialectic-hydraulic-interpretation press, which could press an indefinite number of meanings out of any text or statute, an apparatus for constructing fictions, and a hair-splitting machine that could divide a single hair into 999,999 equal parts and, when operated by the most expert jurists, could split each of these parts again into 999,999 equal parts . . . [was] open to all properly qualified jurists, provided only they drank the Lethean draught which induced forgetfulness of terrestrial human affairs.
This was the realm of transcendental nonsense in which legal questions were resolved by examining the relationships among abstract concepts divorced from any consideration of the practical consequences or ethical quality of the decision.
As his first illustration of transcendental nonsense, Cohen selected the law's treatment of corporations. He pointed out that in deciding whether a corporation incorporated in one state could be sued in the courts of another, one might expect courts to make “some factual inquiry into the practice of modern corporations in choosing their sovereigns and into the actual significance of the relationship between a corporation and the state of its incorporation,” to consider “the difficulties that injured plaintiffs may encounter if they have to bring suit against corporate defendants in the state of incorporation . . . [and] the possible hardship to corporations of having to defend actions in many states, considering the legal facilities available to corporate defendants,” and to decide the case “[o]n the basis of facts revealed by such an inquiry, and on the basis of certain political or ethical value judgments as to the propriety of putting financial burdens upon corporations . . . .” Yet, when the New York Court of Appeals was called upon to rule on this matter, “[i]nstead of addressing itself to such economic, sociological, political, or ethical questions . . ., the court addressed itself to the question, ‘Where is a corporation?’ Was this corporation really in Pennsylvania or in New York, or could it be in two places at once?”
But how is such a question to be answered? As Cohen pointed out,
Clearly the question of where a corporation is, when it incorporates in one state and has agents transacting corporate business in another state, is not a question that can be answered by empirical observation. Nor is it a question that demands for its solution any analysis of political considerations or social ideals. It is, in fact, a question identical in metaphysical status with the question which scholastic theologians are supposed to have argued at great length, “How many angels can stand on the point of a needle?”
Nevertheless, the court ruled that the corporation could be sued in New York because by maintaining an office there, the corporation had come into the state. The problem with this ruling is that
[n]obody has ever seen a corporation. What right have we to believe in corporations if we don't believe in angels? To be sure, some of us have seen corporate funds, corporate transactions, etc. . . . But this does not give us the right to hypostatize, to “thingify,” the corporation, and to assume that it travels about from State to State as mortal men travel. Surely we are qualifying as inmates of . . . [the] heaven of legal concepts when we approach a legal problem in these essentially supernatural terms.
Deciding cases by reifying the abstract concept of the corporation is a classic example of transcendental nonsense.
Put simply, I just can't wrap my head around the metaphysical abstractions required to think of the corporation as an entity--real or otherwise--rather than as an aggregate. Being unable to perform the mental gymnastics necessary to "thingify" the corporation, I am happy to find such a distinguished precedent for dismissing the effort so blithely. After all, as James Boyle wrote (62 U. Colo. L. Rev. 489):
The realist attack was particularly effective in corporation law, where the “constructed” nature of the subject was more apparent. In Transcendental Nonsense and the Functionalist Approach, Felix Cohen suggests that the question “where is a corporation” is the kind of nonsense you can expect from scholastics drunk on their own wordy theories. In fact, talking about whether the corporation is “in the jurisdiction”--or even exists at all--is simply a way of expressing our conclusions about the “policy question” of whether we wish to hold the corporation liable, or grant its directors immunity from suit, or whatever. In other words, to talk of the legal subject is merely to restate a conclusion reached on other grounds. Legal subjects pop in and out of being as a (mysteriously arrived at) set of policy conclusions changes and shifts.
Speaking as a "Reagan realist," i.e., someone who "recognizes the contingent nature of law but insists that such contingency is limited by moral, political, and cultural values that are essentially conservative" (47 Hous. L. Rev. 297), that strikes me as basically right.
Anyway, be sure to go read Prof Padfield's article. It's provocative, thoughtful, and engaging.