The Seattle University Law Review recently published a symposium devoted to a 15 year retrospective on Margaret Blair and Lynn Stout’s article A Team Production Theory of Corporate Law. Deservedly so. It was a provocative article that advanced the ball in many respects. Ultimately, however, I was unpersuaded and explained why in my article Director Primacy: The Means and Ends of Corporate Governance, 97 Nw. U. L. Rev. 547, 592-600 (2003). The following excerpt is taken from my original draft. I offer it up as a rebuttal to the recent symposium. In doing so, however, I am reminded of the lyrics of a Dave Mason song:
...we can't see eye to eye.
There ain't no good guy, there ain't no bad guy,
There's only you and me and we just disagree.
Blair and Stout contend that corporate law treats directors not as hierarchs charged with serving shareholder interests, but as referees—mediating hierarchs, to use their term—charged with serving the interests of the legal entity known as the corporation. In turn, the corporation’s interests are defined as the “joint welfare function” of all constituents who make firm specific investments. Although Blair and Stout tend to downplay the normative implications of their model, they acknowledge that it “resonates” with the views of progressive corporate legal scholarship. They differ from the progressive wing of the corporate law academy mainly on positive grounds. Many progressives believe that corporate directors currently do not take sufficient account of nonshareholder constituency interests and that law reform is necessary. In contrast, Blair and Stout believe that corporate directors do take such interests into account and the current law is adequate in this regard.
Team production is an important and highly useful concept in neoinstitutional economics. Blair and Stout stretch the team production model to encompass the entire firm. Doing so is unconventional. In my view, stretching team production that far also detracts from the model’s utility.
Production teams are defined conventionally as “a collection of individuals who are interdependent in their tasks, who share responsibility for outcomes, [and] who see themselves and who are seen by others as an intact social entity embedded in one or more larger social systems ....” This definition contemplates that production teams are embedded within a larger entity. As one commentator defines them, teams are “intact social systems that perform one or more tasks within an organizational context.”
Building on the work of Rajan and Zingales, Blair and Stout define team production by reference to firm specific investments. Hence, for example, they describe the firm “as a ‘nexus of firm-specific investments.’” In fact, however, firm specific investments are not the defining characteristic of team production. Instead, the common feature of team production is task nonseparability.
Oliver Williamson identifies two forms production teams take: primitive and relational. In both, team members perform nonseparable tasks. The two forms are distinguished by the degree of firm specific human capital possessed by such members. In primitive teams, workers have little such capital; in relational teams, they have substantial amounts. Because both primitive and relational team production requires task nonseparability, it is that characteristic that defines team production.
Most public corporations have both relational and primitive teams embedded throughout their organizational hierarchy. Self-directed work teams, for example, have become a common feature of manufacturing shop floors and even some service workplaces. Even the board of directors can be regarded as a relational team. Hence, the modern public corporation arguably is better described as a hierarchy of teams rather than one of autonomous individuals. To call the entire firm a team, however, is neither accurate nor helpful.
As among shop floor workers organized into a self-directed work team, for example, team production is an appropriate model precisely because their collective output is not task separable. In a large firm, however, the vast majority of tasks performed by the firm’s various constituencies are task separable. The contribution of employees of one division versus those of a second division can be separated. The contributions of employees and creditors can be separated. The contributions of supervisory employees can be separated from those of shop floor employees. And so on. Accordingly, the concept of team production is simply inapt with respect to the large public corporations with which Blair and Stout are concerned. 
John Coates argues that Blair and Stout’s mediating hierarch model fares poorly whenever there is a dominant shareholder. If so, the model’s utility is vitiated with respect to close corporations, wholly-owned subsidiaries, and publicly held corporations with a controlling shareholder. In addition, Coates argues, Blair and Stout’s model also fares poorly whenever any corporate constituent dominates the firm. Many of publicly held corporations lacking a controlling shareholder are dominated one of the constituents among which the board supposedly mediates—namely, top management. Although the precise figures disputed, a substantial minority of publicly held corporations have boards in which insiders comprise a majority of the members. Even where a majority of the board is nominally independent, the board may be captured by insiders.
I more skeptical than Coates of board capture theories, having argued elsewhere that independent board members have substantial incentives to buck management. On balance, however, Coates makes a persuasive case that the mediating hierarch model has a relatively small domain. In contrast, the domain of director primacy, which merely requires the absence of a controlling shareholder, seems considerably larger.
Blair and Stout develop the mediating hierarchy model by telling the story of a start-up venture in which a number of individuals come together to undertake a team production project. The participating constituents know that incorporation, especially the selection of independent board members, will reduce their control over the firm and, consequently, expose their interests to shirking or self-dealing by other participants. They go forward, Blair and Stout suggest, because the participants know the board of directors will function as a mediating hierarch resolving horizontal disputes among team members about the allocation of the return on their production.
On its face, Blair and Stout’s scenario is not about established public corporations. Instead, their scenario seems heavily influenced by the high-tech start-ups of the late 1990s. Yet, even in that setting, the model seems inapt. In the typical pattern, the entrepreneurial founders hire the first factors of production. If the firm subsequently goes public, the founding entrepreneurs commonly are replaced by a more or less independent board. The board thus displaces the original promoters as the central party with whom all other corporate constituencies contract. It is due to my empirical impression that this is the typical pattern that director primacy assumes the board of directors—whether comprised of the founding entrepreneurs or subsequently appointed outsiders—hires factors of production, not the other way around.
Lest the foregoing seem like an argument for shareholder primacy, I think it is instructive to note the corporation—unlike partnerships, for example—did not evolve from enterprises in which the owners of the residual claim managed the business. Instead, as a legal construct, the modern corporation evolved out of such antecedent forms as municipal and ecclesiastical corporations. The board of directors as an institution thus pre-dates the rise of shareholder capitalism. When the earliest industrial corporations began, moreover, they typically were large enterprises requiring centralized management. Hence, separation of ownership and control was not a late development but rather a key institutional characteristic of the corporate form from its inception. At the risk of descending into chicken-and-egg pedantry, the historical record thus suggests that director primacy emerged long before shareholder primacy. Directors have always hired factors of production, not vice-versa.
In Blair and Stout’s model, directors are hired by all constituencies and charged with balancing the competing interests of all team members “in a fashion that keeps everyone happy enough that the productive coalitions stays together.” In other words, the principal function of the mediating board is resolving disputes among other corporate constituents. This account of the board’s role differs significantly from the standard account.
The literature typically identifies three functions performed by boards of public corporations: First, and foremost, the board monitors and disciplines top management. Second, while boards rarely are involved in day-to-day operational decisionmaking, most boards have at least some managerial functions. Broad policymaking is commonly a board prerogative, for example. Even more commonly, however, individual board members provide advice and guidance to top managers with respect to operational and/or policy decisions. Finally, the board provides access to a network of contacts that may be useful in gathering resources and/or obtaining business. Outside directors affiliated with financial institutions, for example, apparently facilitate the firm’s access to capital. In none of these capacities, however, does the board of directors directly referee between corporate constituencies.
To be sure, institutional economics acknowledges that dispute resolution is an important function of any governance system. Ex post gap-filling and error correction are necessitated by the incomplete contracts inherent in corporate governance. Those functions inevitably entail dispute resolution. As we’ve seen, the firm addresses the problem of incomplete contracting by creating a central decisionmaker authorized to rewrite by fiat the implicit—and, in some cases, even the explicit—contracts of which the corporation is a nexus.
As the principal governance mechanism within the public corporation, the board of directors is that central decisionmaker and, accordingly, bears principal dispute resolution responsibility. Yet, in doing so, the board “is an instrument of the residual claimants.” Hence, if the board considers the interests of nonshareholder constituencies when making decisions, it does so only because shareholder wealth will be maximized in the long-run.
If directors suddenly began behaving as mediating hierarchs, rather than shareholder wealth maximizers, an adaptive response would be called forth. Consistent with the predictions developed above, shareholders would adjust their relationships with the firm, demanding a higher return to compensate them for the increase in risk to the value of their residual claim resulting from director freedom to make trade-offs between shareholder wealth and nonshareholder constituency interests. Ironically, this adaptation would raise the cost of capital and thus injure the interests of all corporate constituents whose claims vary in value with the fortunes of the firm.
Because a model’s ability to predict real world outcomes is more important than the extent to which the model’s assumptions accurately depict the real world, the key question is whether the mediating hierarchy model facilitates accurate predictions about the content of the law. To support their claim that the mediating hierarch model explains the substantive content of corporate law as it exists today, Blair and Stout examine a substantial number of doctrinal principles. Out of consideration for the long-suffering reader, because delving deeply may be more instructive than taking a broad overview, and so as to leave something for future articles, I focus here on a single doctrine—the business judgment rule.
The business judgment rule is the separation of ownership and control’s chief common law corollary. It pervades every aspect of the state law of corporate governance, from allegedly negligent decisions by directors, to self-dealing transactions, to board decisions to seek dismissal of shareholder litigation, and so on. Enabling one to make accurate predictions about the business judgment rule’s scope and content thus stands as the basic test for any model.
Blair and Stout correctly assert that the business judgment rule does not reflect a norm of shareholder primacy, but err in suggesting that the business judgment rule does not reflect a norm of shareholder wealth maximization. The case law, properly understood, does not stand for the proposition that directors have discretion to make trade-offs between nonshareholder and shareholder interests. Instead, the cases stand for the proposition that courts will abstain from reviewing the exercise of directorial discretion even when the complainant alleges that directors took nonshareholder interests into account in making their decision.
The question is one of means and ends. In the classic case of Dodge v. Ford Motor Co., the court emphasized that director discretion is the means by which corporations are governed. More recently, the Delaware supreme court explained:
Under Delaware law, the business judgment rule is the offspring of the fundamental principle, codified in [Delaware General Corporation Law] § 141(a), the business and affairs of a Delaware corporation are managed by or under its board of directors.... The business judgment rule exists to protect and promote the full and free exercise of the managerial power granted to Delaware directors.
In other words, the rule ensures that the null hypothesis is deference to the board’s authority as the corporation’s central and final decisionmaker. On this Blair and Stout and I agree. We part company, however, when they deny that the end towards which corporations are governed is, as the Dodge court put it, “the profit of the stockholders.”
Put another way, we agree that the business judgment rule exists to preserve director discretion, but disagree as to why that discretion is important. Blair and Stout contend that the business judgment rule insulates the board of directors from “the direct command and control” of shareholders (or other corporate constituents for that matter) so as to prevent the various constituents from opportunistically expropriating rents from the team. In contrast, I contend that the business judgment rule is the doctrinal mechanism by which courts on a case-by-case basis resolve the competing claims of authority and accountability.
As a positive theory of corporate governance, director primacy claims that fiat—centralized decisionmaking—is the essential attribute of efficient corporate governance. As a normative theory of corporate governance, director primacy claims that authority and accountability cannot be reconciled. As Kenneth Arrow observed:
[Accountability mechanisms] must be capable of correcting errors but should not be such as to destroy the genuine values of authority. Clearly, a sufficiently strict and continuous organ of [accountability] can easily amount to a denial of authority. If every decision of A is to be reviewed by B, then all we have really is a shift in the locus of authority from A to B and hence no solution to the original problem.
The business judgment rule prevents such a shift in the locus of decisionmaking authority from boards to judges. It does so by establishing a limited system for case-by-case oversight in which judicial review of the substantive merits of those decisions is avoided. The court begins with a presumption against review. It then reviews the facts to determine not the quality of the decision, but rather whether the decisionmaking process was tainted by self-dealing and the like. The questions asked are objective and straightforward: Did the board commit fraud? Did the board commit an illegal act? Did the board self-deal? Whether or not the board exercised reasonable care is irrelevant, as well it should be. The business judgment rule thus builds a prophylactic barrier by which courts pre-commit to resisting the temptation to review the merits of the board’s decision. This is precisely the rule for which shareholders would bargain, because they would conclude that the systemic costs of judicial review exceed the benefits of punishing director misfeasance and malfeasance.
One of the reasons empirical scholarship often bugs me is that the answers you get are so dependent on how you set up the problem and crunch the numbers. One is frequently reminded of Harry S Truman's plea for a one handed economist.
Case in point:
In October 22nd 2014, ISS published a note on the financial consequences for shareholders to vote “NO” to a proposed takeover (available in an article by Steven Davidoff Solomon,“The Consequences of Saying No to a Hostile Takeover Bid”, published on October 28th, 2014, in the New York Times DealBook). ISS claims to have demonstrated that those shareholders who voted “No” to a proposed takeover of their company would have been better off financially, had they agreed to the takeover.
Unfortunately, the ISS note does not support such a blanket statement. Our take on the ISS paper highlights many debatable aspects of their analysis. We show that the paper produced by ISS to support the position of hostile bidders falls flat. It is marred by dubious analytical choices, questionable metrics and the remarkable absence of a key investment parameter, the risk/return relationship.
Allaire, Yvan and Dauphin, Francois, The Value of 'Just Say No': A Response to ISS (November 6, 2014). Available at SSRN: http://ssrn.com/abstract=2531132.
My normative priors tempt me to embrace this finding, of course.
... economic theory says we should make decisions based only on the costs and benefits that a course of action has in the future, not on “sunk costs,” which we’ll never get back. When you finish a plate of food you don’t really want just because you already paid for it, you’re falling victim to the sunk cost fallacy. On a bigger scale, the sunk cost fallacy can lead a company to keep pouring money into a failed venture, or a nation to keep pouring resources into a hopeless war.
Which brings us back to the Redskins.
In other words, all those draft picks the 'Skins gave up ought to be irrelevant to the decision of whether to make Kirk Cousins the starting QB.
But is Dan Snyder smart enough to see it?
Some of the hardest working people I know are Catholic priests. I knew one priest who kept working even though he was severely suffering from Parkinson's syndrome. I know another priest who is still working despite being in late stage Lou Gehrig disease. My current priest is busting his butt at an age when I hope to be fishing (metaphorically, of course, because I actually hate fishing). I admire them all greatly. But as a law and economics guy who starts with the assumption that people are rational actors, I am puzzled by them.
I've been noodling for a long time with a research project inspired by Jay Hartzell, Christopher Parsons & David Yermack's paper Incentive Compensation in the Church (February 8, 2010). Journal of Labor Economics, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1303853. Here's the abstract:
We study the compensation and productivity of more than 2,000 Methodist ministers in a 43-year panel data set. The church appears to use pay-for-performance incentives for its clergy, as their compensation follows a sharing rule by which pastors receive approximately 3% of the incremental revenue from membership increases. Ministers receive the strongest rewards for attracting new parishioners who switch from other congregations within their denomination. Monetary incentives are weaker in settings where ministers have less control over their measured performance.
This leads to a problem known as sheep stealing. But set that issue aside for a minute. In the Great Commission, Jesus told the apostles "go and make disciples of all nations, baptizing them in the name of the Father and of the Son and of the Holy Spirit, and teaching them to obey everything I have commanded you." As successors of the apostles, priests have that same duty. The Methodists appear to incent their pastors to fulfill the Great Commission by using pay, which is what an economist (or economically-minded lawyer) would expect.
As I understand it, however, Catholic dioscean priests get paid the same--regardless of how big or small their parish congregation may be and regardless of whether it is growing or not. (And, of course, there are the religious orders whose priests have taken a vow of poverty, but let's not complcate things too much.)
This presents two questions relevant to my project:
These questions are interesting to me because I'm a legal academic who studies how law affects behavior. Of late, I've become increasingly interested in how canon law might influence the behavior of priests just as corporate law influences executives. Churches and corporations are both organizations run by people and governed by a set of laws. Perhaps the tools we use to study the latter might inform our understanding of the former.
I'm also interested in the question as a Catholic. The Catholic Church has long had a reputation - whether deserved or not - for avoiding active evangelization. One of the many changes Pope Francis is making, however, is to encourage a commitment to evangelization.
They say virtue is its own reward. I wonder, however, if Pope Francis' call would have better results if canon law and priestly compensation were structured so as to incent church leaders to lead in this area.
New study by Francis, Bill and Hasan, Iftekhar and Wu, Qiang, Professors in the Boardroom and Their Impact on Corporate Governance and Firm Performance (July 9, 2014). Forthcoming in Financial Management; Bank of Finland Research Discussion Paper No. 15/2014. Available at SSRN: http://ssrn.com/abstract=2474522:
Directors from academia served on the boards of around 40% of S&P 1,500 firms over the 1998-2011 period. This paper investigates the effects of academic directors on corporate governance and firm performance. We find that companies with directors from academia are associated with higher performance and this relation is driven by professors without administrative jobs. We also find that academic directors play an important governance role through their advising and monitoring functions. Specifically, our results show that the presence of academic directors is associated with higher acquisition performance, higher number of patents and citations, higher stock price informativeness, lower discretionary accruals, lower CEO compensation, and higher CEO forced turnover-performance sensitivity. Overall, our results provide supportive evidence that academic directors are valuable advisors and effective monitors and that, in general, firms benefit from having academic directors.
Anne Tucker writes:
As most readers will know, Blair and Stout theorized that in this situation where various stakeholders make different types of investment (capital, human/labor, etc.) and where it is hard to tell what is earned from each separate contribution, that the stakeholders leave decisions up to the board of directors-- a mediating hierarchy--to apportion the gains and monitor the firm.
I have nothing but respect for Margaret and Lynn, and while their team production model has some overlap with my director primacy model, I have (obviously) preferred the latter. I gave a detailed critique of team production in Director Primacy: The Means and Ends of Corporate Governance, 97 Northwestern University Law Review 547 (2003), much of which was later revised and updated in my book The New Corporate Governance in Theory and Practice.
Issue # 2 of Volume 11 of Econ Journal Watch includes a symposium which "suggests that mainstream economics has unduly flattened economic issues down to certain modes of thought (such as ‘Max U’); it suggests that economics needs enrichment by formulations that have religious or quasi-religious overtones." Among the articles is a very interesting one by my friend Eric Rasmussen, the abstract of which explains:
The Prologue to this issue discusses how the flatness of economics leaves out aspects of reality that do not fit neatly into its formulations. I agree that much is left out, but I am not so sure methodology is to blame. Rather, the omission is caused by our restriction of economic methodology to particular assumptions about reality. In this essay, I first show that something like utility maximization has long been present in Christian theology. To be sure, economics is ‘flat’ in its style and, unlike religion, excludes by custom certain scholarly tools which would complement the flat approach. I argue, however, that the essential difference is that some religions, in particular Christianity, take their start from belief in factual assumptions that economics ignores.
A January 10th Wall Street Journal article pointed out how financial aid results in some students subsidizing other students' education:
Well-off students at private schools have long subsidized poorer classmates. But as states grapple with the rising cost of higher education, middle-income students at public colleges in a dozen states now pay a growing share of their tuition to aid those lower on the economic ladder.
The student subsidies, which are distributed based on need, don't show up on most tuition bills. But in eight years they have climbed 174% in real dollars at a dozen flagship state universities surveyed by The Wall Street Journal.
During the 2012-13 academic year, students at these schools transferred $512,401,435 to less well-off classmates, up from $186,960,962, in inflation-adjusted figures, in the 2005-06 school year.
At private schools without large endowments, more than half of the tuition may be set aside for financial-aid scholarships. At public schools, set-asides range between 5% and 40% according to the Journal's survey.
I've frequently witnessed this phenomenon. Every time a school I attended or taught at raised tuition, we were told that financial aid would be going up too. But is it fair or efficient that some students subsidize others? In today's WSJ letters column, a professor at the University of Tampa argues that financial aid is just a perfectly acceptable form of price discrimination:
Colleges are following a pricing strategy employed by airlines, car dealerships and other businesses. Customers who are able and willing to pay more are charged more. Anyone who has studied microeconomics principles knows both revenue and profitability increase as do the total number of customers served.
Colleges engage in scholarship programs (price-discrimination strategies). Eliminating or reducing these programs would result in some private colleges closing, enrollment overall would decrease and the percentage of the population receiving college degrees would decrease.
I think that he's basically right that financial aid is a form of price discrimination. Indeed, colleges and universities are uniquely positioned engage in price discrimination, as Richard Morrison observes (57 U Chi L Rev 801):
Colleges and universities are uniquely positioned to price discriminate among students because the barriers that may prevent businesses from practicing perfect price discrimination do not restrict them. First, ordinary firms are usually unable to ascertain the maximum amount each consumer is willing to pay for a product. However, the information schools obtain from financial aid forms, especially students' income and assets, greatly aid them in determining each student's reservation price. Students who misrepresent their income on financial aid forms face severe penalties, thus insuring that the schools have reliable information on which to base their estimates of reservation prices.
Second, schools do not face the problem of arbitrage. Businesses that price discriminate often find that low-paying customers will sell their purchases to high-paying consumers, luring the high-paying customers away from the original supplier. Financial aid recipients, on the other hand, cannot sell their university places to those students who do not receive financial aid.
I'm also prepared to accept that price discrimination is not the unmitigated evil that politicians and lawyers believe it to be.
Yet, I think it's worth noting that price discrimination in the form of financial aid has been a major driver in the higher than ordinary inflation rate of increase in higher education costs:
Gordon Winston in Hierarchy and Peers: The Awkward Economics of Higher Education, 13 Journal of Economic Perspectives 3 (1999), argues that tuition keeps rising because “sticker prices have risen to allow more price discrimination in the form of financial aid among potential buyers.” As Joseph B. Keillor likewise observes (87 Wash. U. L. Rev. 175):
One prominent economist [Thomas Sowell] has explained that the federal funding of higher education in general enables universities to price discriminate like monopolies, and skews market factors so that universities have “no incentive to keep tuition affordable and every incentive to make it unaffordable.” Financial aid forms provide colleges with detailed financial information about applicants and their families, thereby facilitating price discrimination as colleges “set an unrealistically high list price and then offer varying discounts. In academia, this list price is called tuition and the discount is called ‘financial aid’ . . . . [T]he net price actually charged is adjusted to the most that can be extracted from each applicant's family” and the government. Indeed, tuition has skyrocketed since the federal government initiated substantial funding of higher education through the Higher Education Act of 1965.
Worse yet, the ability to price discriminate via financial aid has led to collusion, as illustrated by the infamous case of the “Ivy Overlap Group,” which further jacked up prices at a rate well in excess of inflation. As Morrison explains:
… elite private colleges probably have more market power when they operate as a cartel, and thus are able to charge some consumers higher prices without driving them away. The more market power a firm or cartel has, the greater its ability to charge differential prices. A price discriminating cartel makes more profit than either an individual price discriminator or a cartel that is unable to price discriminate. Thus an individual school, lacking the cartel's combined market power, would not be able to price discriminate as effectively. Even though individual schools may legally engage in price discrimination, the added power of the cartel may increase the wealth transfer away from students and to the participating colleges and universities.
And that's the point. The ability to engage in rampant price discrimination results in a wealth transfer from the middle class and the taxpayer not to poor families but to bloated university administrations and all the other well-documented abuses that raging tuition inflation has occasioned.
Blogosphere commentary on the passing of Ronald Coase, to accompany my earlier post, includes:
Professor Coase joined the University of Chicago Law School faculty in 1964, and received the Nobel Prize in Economics in 1991. He continued to produce scholarly work into his 100s! In a survey of readers several years ago, Coase ranked 4th (after Holmes, Posner, and Dworkin) among the most influential legal thinkers in American law of the past century. It was a remarkable act of foresight for the Law School to hire Coase, who did not have a law degree, and to do so long before interdisciplinary scholarship had become the norm at leading law schools.
Ronald Coase, the Nobel Prize winning economist and legal theorist, has passed. He had a profound influence on law and economics. His essay, The Problem of Social Cost, is the single most influential law and economics article--and surely one of the most influential legal theory pieces from any methodological perspective. Among his many other essays, The Federal Communications Commission and The Nature of the Firm were both hugely influential. He was a giant!
The Coase theorem was first presented by Coase in his 1959 work on the FCC and allocating radio spectrum (jstor). Radio stations interfered with one another (i.e. externalities). Yet Coase argued that with well-defined property rights, spectrum could be allocated in a market just like other goods. In this talk from our MRUniversitycourse, Economics of the Media, I discuss spectrum allocation, Coase’s triumph at the Chicago dinner and the much longer time to acceptance and application in the real world of the FCC and spectrum auctions.
Not surprisingly, we’ve discussed Coase quite a bit here at Truth on the Market. Follow this link to see our collected thoughts on Coase over the years.
Probably my favorite, and certainly most frequently quoted, of Coase’s many wise words is this:
One important result of this preoccupation with the monopoly problem is that if an economist finds something—a business practice of one sort or other—that he does not understand, he looks for a monopoly explanation. And as in this field we are very ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on a monopoly explanation, frequent.
University of Chicago announcement:
Ronald H. Coase helped create the field of law and economics, through groundbreaking scholarship that earned him the 1991 Nobel Memorial Prize in Economics and through his far-reaching influence as a journal editor.
Coase, who spent most of his academic career at the University of Chicago Law School, died at the age of 102 on Sept. 2 at St. Joseph’s Hospital in Chicago. He was the oldest living Nobel laureate, according to the Nobel Foundation.
Coase, the Clifton R. Musser Professor Emeritus of Economics, is best known for his 1937 paper, “The Nature of the Firm,” which offered groundbreaking insights about why firms exist and established the field of transaction cost economics, and “The Problem of Social Cost,” published in 1960, which is widely considered to be the seminal work in the field of law and economics. The latter set out what is now known as the Coase Theorem, which holds that under conditions of perfect competition, private and social costs are equal.
I was never lucky enough to meet Coase, but his work enormously impacted my understanding of how corporations work and why they exist. So I borrow here from a 2003 post, in which I reviewed Coase's book The Firm, the Market, and the Law, which included reprints of his major articles:
This is principally a collection of Coase's seminal works, although it does contain some useful new material. In particular, the opening chapter is entirely new and shows how a consistent theory of firms and markets, as well as a unique conception of economics and economically-oriented scholarship, runs through Coase's work from the 1930s to the late 1980s (when the book was published).
Coase is best known for two seminal articles. The earlier article "The Theory of the Firm" is the seminal work on the so-called nexus of contracts theory of the firm, as well as an early source for the transaction cost branch of the New Institutional Economics. The nexus of contracts model treats the firm not as an entity, but as an aggregate of various inputs acting together to produce goods or services. Employees provide labor. Creditors provide debt capital. Shareholders initially provide equity capital and subsequently bear the risk of losses and monitor the performance of management. Management monitors the performance of employees and coordinates the activities of all the firm's inputs. The firm is simply a legal fiction representing the complex set of contractual relationships between these inputs. Besides emphasizing the importance of examining the various contracts making up the firm, however, Coase's fundamental insight was that the contractual nature of the firm does not preclude an element of command and control absent from market transactions. If a corporate employee moves from department Y to department X he does so not because of change in relative prices, but because he is ordered to do so. In other words, markets allocate resources via the price mechanism but firms allocate resources via authoritative direction. The set of contracts making up the firm consists in very large measure of implicit agreements, which by definition are both incomplete and unenforceable. Under conditions of uncertainty and complexity, the firm's many constituencies cannot execute a complete contract, so that many decisions must be left for later contractual rewrites imposed by fiat. It is precisely the unenforceability 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.
Even better known, and even more central to transaction cost economics, however, is Coase's later article "The Problem of Social Cost," which also is reprinted in full here. In that article, Coase laid a critical foundation of modern law and economics - the so-called Coase theorem. The Coase theorem has been formulated in various ways, but one useful statement might be that: "When the parties can bargain successfully, the initial allocation of legal rights does not matter." Suppose a steam locomotive drives by a field of wheat. Sparks from the engine set crops on fire. Should the railroad company be liable? In a world of zero transaction costs, the initial assignment of rights is irrelevant. If the legal rule we choose is inefficient, the parties can bargain around it. Put another way, according to the Coase theorem, rights will be acquired by those who value them most highly, which creates an incentive to discover and implement transaction cost minimizing governance forms.
The Coase theorem has been widely criticized. The second major set of new material in this book is a chapter entitled "Notes on the Problem of Social Cost," in which Coase answers the more serious criticisms. That essay provides a useful intellectual history of the Coase theorem, as well as a trenchant defense of its main claims. One of the less-well informed criticisms of Coase is that he assumes transaction costs are zero. He does not, as this new essay makes clear. Indeed, as Coase points out, the interesting cases are those in which transactions costs are non-zero. In a world of positive transaction costs, however, the parties may not be able to bargain. This is likely to be true in our example. The railroad travels past the property of many landowners, who put their property to differing uses and put differing values on those uses. Negotiating an optimal solution will all of those owners would be, at best, time consuming and onerous. Hence, the allocation of legal rights becomes quite important.
My article, Unocal at 20: Director Primacy in Corporate Takeovers, was included in Law and Economics of Mergers and Acquisitions, edited by Steven Davidoff and Claire Hill. Other (lesser) articles included therein include:
Introduction Steven M. Davidoff and Claire A. Hill
PART I BACKGROUND: HISTORY, RATIONALES AND OUTCOMES
1. Henry G. Manne (1965), ‘Mergers and the Market for Corporate Control’
2. Michael Jensen (1989), ‘Eclipse of the Public Corporation’
3. Bernard S. Black (1989), ‘Bidder Overpayment in Takeovers’
4. Robert F. Bruner (2004), ‘Does M&A Pay?’
5. Ulrike Malmendier and Geoffrey Tate (2008), ‘Who Makes Acquisitions? CEO Overconfidence and the Market’s Reaction’
PART II WHAT M&A LAWYERS DO
6. Ronald J. Gilson (1984), ‘Value Creation by Business Lawyers: Legal Skills and Asset Pricing’
7. Claire A. Hill (2001), ‘Why Contracts are Written in “Legalese”’
8. John C. Coates IV (2001), ‘Explaining Variations in Takeover Defenses: Blame the Lawyers’
9. Claire A. Hill (2009), ‘Bargaining in the Shadow of the Lawsuit: A Social Norms Theory of Incomplete Contracts’
PART III HOW DEALS ARE DONE: BOARD FIDUCIARY DUTIES
10. William T. Allen, Jack B. Jacobs and Leo E. Strine, Jr. (2002), ‘The Great Takeover Debate: A Meditation on Bridging the Conceptual Divide’
11. Stephen M. Bainbridge (2006), ‘Unocal at 20: Director Primacy in Corporate Takeovers’
12. Matthew D. Cain and Steven M. Davidoff (2011), ‘Form over Substance? The Value of Corporate Process and Management Buy-Outs’
PART IV HOW DEALS ARE DONE: PROCESS
13. Lawrence A. Hamermesh (2002), ‘A Kinder, Gentler Critique of Van Gorkom and its Less Celebrated Legacies’
14. Audra L. Boone and J. Harold Mulherin (2007), ‘How Are Firms Sold?’
15. Lawrence A. Hamermesh and Michael L. Wachter (2009), ‘Rationalizing Appraisal Standards in Compulsory Buyouts’
PART V DEFENDING THE CORPORATE BASTION: PROTECTIVE DEVICES GENERALLY
16. Martin Lipton and Paul K. Rowe (2002), ‘Pills, Polls, and Professors: A Reply to Professor Gilson’
17. Lucian Arye Bebchuk, John C. Coates IV and Guhan Subramanian (2002), ‘The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy’
18. Brett H. McDonnell (2005), ‘Shareholder Bylaws, Shareholder Nominations, and Poison Pills’
An introduction by the editors to both volumes appears in Volume I
PART I RESPONDING TO A HOSTILE APPROACH
1. Guhan Subramanian (2003), ‘Bargaining in the Shadow of Takeover Defenses’
2. Marcel Kahan and Edward B. Rock (2002), ‘How I Learned to Stop Worrying and Love the Pill: Adaptive Responses to Takeover Law’
3. Bernard Black and Reinier Kraakman (2002), ‘Delaware’s Takeover Law: The Uncertain Search for Hidden Value’
PART II PROTECTING THE DEAL
4. John C. Coates IV and Guhan Subramanian (2000), ‘A Buy-Side Model of M&A Lockups: Theory and Evidence’
5. Brian J.M. Quinn (2007), ‘Bulletproof: Mandatory Rules for Deal Protection’
6. Guhan Subramanian (2008), ‘Go-Shops vs. No-Shops in Private Equity Deals: Evidence and Implications’
PART III TERMINATING THE DEAL
7. Afra Afsharipour (2010), ‘Transforming the Allocation of Deal Risk Through Reverse Termination Fees’
8. Ronald J. Gilson and Alan Schwartz (2005), ‘Understanding MACS: Moral Hazard in Acquisitions’
PART IV PRIVATE EQUITY
9. William W. Bratton (2008), ‘Private Equity’s Three Lessons for Agency Theory’
10. Brian Cheffins and John Armour (2008), ‘The Eclipse of Private Equity’
11. Steven M. Davidoff (2009), ‘The Failure of Private Equity’
PART V INTERNATIONAL ISSUES
12. John Armour and David A. Skeel, Jr. (2007), ‘Who Writes the Rules for Hostile Takeovers, and Why? – The Peculiar Divergence of U.S. and U.K. Takeover Regulation’
13. Guido Ferrarini and Geoffrey P. Miller (2009), ‘A Simple Theory of Takeover Regulation in the United States and Europe’
14. Christian Kirchner and Richard W. Painter (2002), ‘Takeover Defenses Under Delaware Law, the Proposed Thirteenth EU Directive and the New German Takeover Law: Comparison and Recommendations for Reform’
15. Paul L. Davies, Edmund-Philipp Schuster and Emilie Van de Walle de Ghelcke (2010), ‘The Takeover Directive as a Protectionist Tool?’
Of course, you'll probably also want my treatise on Mergers and Acquisitions.
In the UCLA news:
Is it John Nash, the Nobel Prize–winning mathematician portrayed in a 2001 Oscar-winning biopic? John von Neumann, game theory's founding father? Go back further, much further, urges a UCLA game theory expert and fan of 19th-century novelist Jane Austen.
"Austen's novels are game theory textbooks," Michael Suk-Young Chwe writes in Jane Austen, Game Theorist, which Princeton University Press published April 21. "She's trying to get readers to use their higher thinking skills and to think strategically."
At its most basic level, game theory assesses all the choices available to two (or more) people in a given situation and assigns a numerical value to the benefit each person reaps from each choice. Often, the choice that is most valuable to one player comes at the expense of the other; hence, game theory's best-known phrase — "zero-sum game." But just as frequently, there is a choice with unexpected benefits for both players.
"In game theory, you make choices by anticipating the payoffs for others," Chwe explains.
Chwe argues that Austen explores this concept in all six of her novels, albeit with a different vocabulary than the one used by Nash, von Neumann and other game theory greats some 150 years later. In Austen's romantic fiction, this type of strategic thinking is described as "penetration," "foresight" or "a good scheme."
In "Pride and Prejudice," for instance, Mrs. Bennet, a mother eager to marry off her five daughters, sends her oldest, Jane, on horseback to a neighboring estate, even though she's aware a storm is on the way. "Mrs. Bennet knows full well that because of the rain, Jane's hosts will invite her to spend the night, thus maximizing face time with the eligible bachelor there, Charles Bingley, whom Jane eventually marries," Chwe said.