ProfessorBainbridge.com

Who invented game theory?

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.

 

A papal tournament

Interesting new paper:

This paper shows an application of Promotion Tournaments to religious organizations, which is appropriate, especially in the case of highly ranked institutions such as the Catholic Church. With this objective, we seek to verify the suitability of the use Tournaments in religious organizations, regarding the optimal structure of contracts in order to select, as well as, to promote clerics. Two models are addressed, modified from the originals, through the inclusion of psychic income, both with two clerics with homogeneous skills. Finally, we discuss the advantages and limitations of the Tournaments applied to religious organizations, including its risks and distortions therein.

Oliveira, Lívio Luiz Soares de and Neto, Giacomo Balbinotto, The Problem of the Principal-Agent and Promotion Tournaments in Religious Organizations: Choosing the Pope (February 20, 2013). Available at SSRN: http://ssrn.com/abstract=2221280

Academics on corporate boards boost performance ... so why aren't I on a board?

Francis, Bill, Hasan, Iftekhar and Wu, Qiang, Professors in the Boardroom and their Impact on Corporate Governance and Firm Performance (February 28, 2013). Available at SSRN: http://ssrn.com/abstract=2226411:

Directors from academia served on the boards of more than one third of S&P 1,500 firms over the 1998-2006 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. In addition, we find that professors without administrative jobs drive the positive relation between academic directors and firm performance. We also show that professors’ educational backgrounds affect the identified relationship. For example, academic directors with business-related degrees have the most positive impacts on firm performance among all the academic fields considered in our regressions. Furthermore, we show that academic directors play an important governance role through their monitoring and advising functions. Specifically, we find that the presence of academic directors is associated with higher acquisition performance, higher number of patents, higher stock price informativeness, lower discretionary accruals, lower CEO compensation, and higher CEO turnover-performance sensitivity. Overall, our results provide supportive evidence that academic directors are effective monitors and valuable advisors, and that firms benefit from academic directors.

CEO’s of large firms interested in increasing their profits should click here

Armen Alchian RIP

I had the great privilege of meeting and studying under UCLA economist Armen Alchian at one of Henry Manne's law and economics courses for law professors. He was a brilliant man, a great teacher, and a very good dinner companion. Sadly, he passed away yesterday.

David Henderson has a wonderful obituary in the WSJ:

What was so important about Alchian's work? There were three aspects. First, he was one of the last economists of his generation to communicate mainly in words and not equations. Second, although economists often use the word "unrigorous" to refer to communication in words rather than math, Alchian was profoundly rigorous, writing clearly and carefully and using basic logic to reach sometimes-startling conclusions. As a result, many of Alchian's papers, even those from the 1950s, are still widely cited.

Third, Alchian is known for his textbook, "University Economics," first published in 1964 and later called "Exchange and Production," coauthored with UCLA colleague William R. Allen. That text is unique in economics. It is much more literary and humorous than any other modern economics textbook that deals with complex issues for an undergraduate audience. Example: "Since the fiasco in the Garden of Eden, most of what we get is by sweat, strain, and anxiety."

Henderson goes on to explain that his favorite Alchian article is:

My personal favorite of his published papers is “The Economic and Social Impact of Free Tuition” (1968). Alchian pointed out that government aid to higher education is a transfer to the relatively rich. That’s because people who can make it through college, even though they may have a low current income, have a high wealth.

He compared subsidizing college to subsidizing drilling expenses for someone sitting on a large pool of oil. The untapped student’s potential is the analogue of the untapped oil. Alchian argued that lack of current income might be a justification for loans to aspiring college students but not for outright subsidies.

Don Boudreaux choses a different article:

My favorite Alchian article is his 1959 study “Costs and Outputs.”  If this article – which, amazingly, Alchian pulled from its forthcoming publication in the American Economic Review in order to put it into a festschrift for Bernard Haley edited by Moses Abramovitz (The Allocation of Economic Resources) – were more widely known and grasped, it would completely upend, and vastly improve, the standard textbook treatment of production costs and cost curves.  Among many other benefits of such an Alchianesque improvement would be that economists would no longer be able so easily to confound themselves, while pleasing the antitrust-plaintiffs’ bar, by using familiar costs curves and concepts (e.g., “AVC”) into supposing that so-called ‘predatory pricing’ is a coherent notion.

My favorite Alchian article is one he coauthored with the great Harold Demsetz (also of UCLA), Armen A. Alchian and Harold Demsetz, Production, Information Costs, and Economic Organization, 62 Am. Econ. Rev. 777 (1972), reprinted in The Economics of Legal Relationships 555 (Henry G. Manne ed. 1975).

In an analysis of how firms deal with agency costs, Alchian and Demsetz offered the useful example of two workers who jointly lift heavy boxes into a truck. The marginal productivity of each worker is very difficult to measure and their joint output cannot be easily separated into individual components. In such situations, obtaining information about a team member’s productivity and appropriately rewarding each team member are very difficult and costly. In the absence of such information, however, the disutility of labor gives each team member an incentive to shirk because the individual’s reward is unlikely to be closely related to conscientiousness.

In any team organization, one must have some ultimate monitor who has sufficient incentives to ensure firm productivity without himself having to be monitored. Otherwise, one ends up with a never ending series of monitors monitoring lower level monitors. Alchian and Demsetz solved this dilemma by consolidating the roles of ultimate monitor and residual claimant. According to Alchian and Demsetz, if the constituent entitled to the firm’s residual income is given final monitoring authority, he is encouraged to detect and punish shirking by the firm’s other inputs because his reward will vary exactly with his success as a monitor.

James Buchanan RIP

James Buchanan died on Wednesday, at age 93, and the world lost one of its most creative economic thinkers. Though a free-marketeer to his bones, he made his biggest mark and won the Nobel Prize in 1986 for his work studying economic incentives in government.

With Gordon Tullock, Buchanan developed what became known as "public choice theory." Buchanan described it as the application of the profit motive to government: "It presupposes that if there is value to be gained through politics, persons will invest resources in efforts to capture this value." ...

His work should be required reading for everyone in a government job.

via online.wsj.com

Indeed, it should. I know I benefited immensely from it.

Larry Cunningham on an "Amazing New Corporate Law & Econ Book"

He opines:

If you are interested in corporate law, especially economic analysis of it, you likely will enjoy an impressive new book collecting original pieces by 30 prominent corporate law scholars. Edited by Claire Hill and Brett McDonnell of the University of Minnesota, the book canvases every important topic in corporate law.

After an overview that traces the history of the economic analysis of corporate law, the book addresses corporate constituencies, governance, gatekeepers, government oversight and a few other hot topics not classified.

Within constituencies, topics consider the directors’ role, the roles of other corporate actors, including shareholders, creditors, employees, and other stakeholders along with broader notions of the public interest. 

Internal governance looks at fiduciary duties, shareholder litigation, outside directors, shareholder activism and executive compensation.  

Gatekeeper pieces address lawyers and auditors, as well as rating agencies,  research analysts, D&O insurers and investment banks.

Jurisdiction looks at both domestic federalism as well as comparative perspective.

Unclassified topics address self-dealing, behavioral economics, and market efficiency.

The scholars are the following professors:

Ahdieh, Atanasov, Bainbridge, Black, Blair, Bodie,  Ciccotello,  Clarke, Cunningham, Darbellay, Davidoff, Fairfax,  Ferri, Fisch,  Frankel, Gilson, Griffith, Hill, Kraakman, Langevoort, Lee, McDonnell, Painter, Partnoy, Smith,  Thomas,  Thompson, Walker, and Whitehead.  

It's an expensive volume to be sure (get your library to order a copy), but--if I may say so myself, who shouldn't--my essay alone is worth the price of admission. So really, you get all those {ahem} "lesser" essays for free. Quite a bargain. eh?

Director primacy is about the allocation of power, not how it used

A friend asked me to comment on a draft law review article that discusses three theories about boards of directors in the legal literature: Melvin Eisenberg's "monitoring model" as set out in his classic work The Structure of the Corporation: A Legal Analysis, Margaret Blair and Lynn Stout's mediating hierarch theory, and my director primacy theory.

Obviously, it is flattering to have one's work assessed in the context of such luminous company. Yet, I think there is an important but all too often overlooked difference between my project and those of Eisenberg and Blair/Stout.

Like most legal theorists who write about the board, both Eisenberg and Blair/Stout are concerned with the uses to which the board puts its powers. Eisenberg wants the board to monitor. Blair/Stout want the board to mediate.

In contrast, I did not approach the board of directors from a perspective framed by the question “what does the board do?” Instead, my inquiry started differently. I looked at the language of the DGCL and the MBCA, which both state that the business and affairs of the corporation shall be managed by or under the direction of the board of directors. And I asked, why? Why a board? Why not shareholders? Or employees? Or an imperial CEO?

You see, I start with a premise “that corporate law tends towards efficiency. A state generates revenue from franchise and other taxes imposed on firms that incorporate in the state. The more firms that choose to incorporate in a given state, the more revenue the state generates. Delaware, the runaway winner in this competition, generates so much revenue from incorporations that its resident taxpayers reportedly save thousands of dollars a year. … I ask the reader simply to assume for the sake of argument that the race to the top is generally valid. If so, we need an account of why states “raced” to a governance structure topped by a board of directors.” The New Corporate Governance at x.

I developed the model I call director primacy to provide such an account. Hence, like the statutes, director primacy is about the allocation of power within the firm, and has little to say about how that power is to be used (other than requiring that it be used to maximize shareholder wealth).

In my work, I thus have noted that the literature identifies three functions performed by boards of public corporations. First, the board monitors and disciplines top management. Second, while boards rarely involve themselves in day-to-day operational decision making, most boards perform at least some managerial functions. Broad policy making, for example, is commonly a board prerogative. Even more commonly, however, individual board members provide advice and guidance to top managers with respect to operational and policy decisions. Finally, the board provides the corporation 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, facilitate the firm’s access to capital.

The statutes are indifferent as to how specific boards allocate their time amongst those functions. And so am I.

In contrast, Eisenberg and Blair/Stout—and, I think, my friend—are worried about which of those three should get primary attention and how that chosen role should be defined.

I prefer the statute’s approach to this issue, because I believe firms are heterogeneous. One size does not fit all. Some companies are best served by a board that focuses on service. Others need active monitoring of top management. The statutes let boards define their own role, so as to take into account these differences. And so does director primacy.

In sum, director primacy is about the allocation of power and the decision making norms by which that power is to be used, but is enabling (or, perhaps more precisely, non-prescriptive) with respect to how boards allocate their time and efforts amongst the three basic functions of monitoring, management, and networking.

BTW, I discuss Blair/Stout's team production model at pages 60ff of The New Corporate Governance in Theory and Practice, and Eisenberg at pages 53ff of Corporate Governance after the Financial Crisis.

LAW & ECONOMICS RESEARCH PAPER SERIES: UCLA SCHOOL OF LAW Vol. 14, No. 3

"Framing Contracts - Why Loss Framing Increases Effort"   Yale Law & Economics Research Paper No. 438 UCLA School of Law, Law-Econ Research Paper No. 12-05 RICHARD R. W. BROOKS, Yale University - Law School Email: richard.brooks@yale.edu ALEXANDER STREMITZER, UCLA School of Law Email: stremitzer@law.ucla.edu STEPHAN W. TONTRUP, Max Planck Institute for Research on Collective Goods Email: tontrup@coll.mpg.de Recent evidence from the field (Hossain and List, 2009) suggests that contracts framed in terms of a loss (a deduction is taken for failing to meet a threshold) lead to greater effort than contracts framed in terms of a gain (a bonus is given for meeting a threshold). We investigate two explanations for this framing effect in a laboratory setting. First, we find that the loss frame communicates the expectation that achieving the bonus is the default and that our subjects comply with this expectation. Second, we find evidence for an endowment effect, even though the bonus is just a monetary payment that subjects do not even have in their possession. "Regulating Insider Trading in the Post-Fiduciary Duty Era: Equal Access or Property Rights?"   UCLA School of Law, Law-Econ Research Paper No. 12-08 STEPHEN M. BAINBRIDGE, University of California, Los Angeles (UCLA) - School of Law Email: bainbrid@law.ucla.edu This essay was prepared for a forthcoming book on the law and economics of insider trading.  In Chiarella and Dirks, the Supreme Court based insider trading liability on a breach of a disclosure obligations arising out of a fiduciary relationship. The resulting narrowing of the scope of insider trading liability met substantial resistance from the Securities and Exchange Commission (SEC) and the lower courts. Through both regulatory actions and judicial opinions, the SEC and the courts gradually chipped away at the fiduciary duty rationale. In recent years, the trend has accelerated, with several developments having substantially eviscerated the fiduciary duty requirement.  The current unsettled state of insider trading jurisprudence necessitates rethinking the foundational premises of that jurisprudence from first principles. This essay argues that the correct rationale for regulation insider trading is protecting property rights in information. Although that rationale obviously has little to do with the traditional concerns of securities regulation, this article further argues that the SEC has a sufficiently substantial advantage in detecting and prosecuting insider trading that it should retain jurisdiction over the offense. "Risk and Reward in Stem Cell Products: A New Model for Stem Cell Product Liability"   Boston University Journal of Science and Technology Law, Vol. 18, pp. 102-49, 2012 UCLA School of Law, Law-Econ Research Paper No. 12-09 STEPHEN R. MUNZER, University of California, Los Angeles (UCLA) - School of Law Email: munzer@law.ucla.edu Stem cell products have the potential to give patients access to treatments and cures for diseases and conditions that are currently beyond the scope of modern medicine. There are not yet many stem cell products on the market in the United States, but soon there will be. It therefore makes sense to explore how we should deal with policy issues concerning these products now. This Article examines the problem of how best to handle legal liability for any harm that stem cell products cause. At present, a complex patchwork of federal and state statutes and legal precedents determines whether makers of drugs, biologics, medical devices and combination products are liable for defects. None of these legal materials specifically addresses stem cell products. Because stem cell product development is in its infancy, and because the risks of stem cell products are largely unknown, it is critical that the correct legal regime be in force. Too much legal liability could inhibit research into stem cell product development. Not enough legal liability could unnecessarily harm patients and hinder the use of stem cell products.  This Article crafts a proposal for what the legal rules ought to be for stem cell products to best benefit all parties involved. Far from indulging in standard neoclassical economic analysis, I employ work on bounded rationality, game theory, and other developments to come up with a proposal that has a better chance of working in the real world and with actual, non-maximizing individuals who have inadequate information. In brief, the proposal is a qualified system of strict liability for stem cell products in which patients and manufacturers contribute on a per-product basis to a compensation fund and the federal government acts as an insurer of last resort. Unlike most writing in this area, the liability proposal takes the ethics of risk imposition seriously. "Negligence-Based Proportional Liability: How More Lenient Sanctions Lead to Higher Compliance"   UCLA School of Law, Law-Econ Research Paper No. 12-10 ALEXANDER STREMITZER, UCLA School of Law Email: stremitzer@law.ucla.edu Over the past four decades, in an effort to help plaintiffs, US tort statutes have expanded strict liability, and courts have relaxed the causation requirement in negligence liability by often resolving factual doubts about causation in the plaintiff’s favor. This Article argues that this trend not only contributes to phenomena such as defensive medicine and overly high health care costs but, more surprisingly, also to more people and property being harmed due to negligent treatment and environmental disasters. This is true in the quite common scenarios in which courts suffer from hindsight bias or injurers lack sufficient assets to satisfy judgments against them. Both problems pervade important areas of tort law. This Article not only cautions against the use of strict liability but also argues for restoring a robust causation requirement in negligence liability. Specifically, this Article proposes a new default regime in torts called “negligence-based proportional liability.” This rule would account for causation in probabilistic terms. It would hold a negligent injurer liable for harm discounted by the probability that the harm was caused by the defendant’s breach of a duty. As a more lenient liability rule than what is generally contemplated by many US courts, negligence-based proportional liability reduces defensive behavior and increases compliance relative to all other liability regimes. "A Tribute to Mike Dooley"   98 Virginia Law Review, 2012 UCLA School of Law, Law-Econ Research Paper No. 12-11 STEPHEN M. BAINBRIDGE, University of California, Los Angeles (UCLA) - School of Law Email: bainbrid@law.ucla.edu A personal and professional tribute to Michael P. Dooley, the William S. Potter Professor of Law Emeritus at the University of Virginia School of Law, upon his retirement in 2012. "Patching a Hole in the JOBS Act: How and Why to Rewrite the Rules that Require Firms to Make Periodic Disclosures"   Indiana Law Journal, Vol. 88, No. 1, 2013 Loyola-LA Legal Studies Paper No. 2012-19 UCLA School of Law, Law-Econ Research Paper No. 12-12 MICHAEL D. GUTTENTAG, Loyola Law School Los Angeles Email: michael.guttentag@lls.edu This article considers if or when firms in the United States should be required to comply with federal periodic disclosure requirements. Such a consideration is timely. Provisions in the Jumpstart Our Business Startups Act of 2012 have made it much easier for firms to avoid federal periodic disclosure obligations, but these provisions were enacted based upon on a virtually non-existent legislative record and upended rules established only after careful consideration almost fifty years earlier.  Determining which firms should be required to comply with federal periodic disclosure requirements is best done in the context of a broader understanding of the history and economics of periodic disclosure regulation. This article provides such an understanding. The history of periodic disclosure regulation in the United States is traced back to its origins in the eighteenth century, and the economic analysis of periodic disclosure regulation is updated and refined to incorporate recent findings. Building on this historical and economic understanding of periodic disclosure regulation, I consider anew if or when firms should be required to comply with federal periodic disclosure requirements. The analysis uncovers a flaw in the structure of the rules currently used to determine which firms must make periodic disclosures. To rectify this structural problem, I suggest that firms with a market capitalization of less than $35 million or fewer than 100 beneficial shareholders be granted an automatic exemption from periodic disclosure requirements. All other firms should be provided a choice between: 1) complying with federal periodic disclosure obligations, or 2) implementing measures that would mitigate the need for disclosure regulation, such as restricting share tradability or committing to an acceptable alternative disclosure regime.

 

The Research Handbook on the Economics of Corporate Law

I'm pleased to report that The Research Handbook on the Economics of Corporate Law is now available. I contributed a chapter on director primacy to the Handbook.

The Introduction by Claire Hill and Brett McDonnell is available on line from SSRN:

Abstract: This essay is the Introduction to the Research Handbook on the Economics of Corporate Law. After briefly surveying the origins of modern economic analysis of corporate law, it analyzes leading developments in recent decades. Major developments in the law and economics of corporate law have in some cases followed from developments in the law, including changes in fiduciary duty standards, the growth of shareholder activism, the increasing role of independent directors, changes in executive compensation, a new emphasis on various gatekeepers, federalization of corporate governance rules, and globalization. Other developments have followed from trends within economics, including some new ideas in the theory of the firm, greater emphasis on empirical research, a focus on market failures due to incomplete information, the growth of behavioral economics, and some increased emphasis on comparative institutional analysis. The essay speculates that future developments may include a new focus on systemic risk in light of the financial crisis and greater use of empirical research methodologies other than regression analysis. The essay concludes with an overview of the contributions to the volume, which is divided into five Parts: corporate constituencies, insider governance, gatekeepers, jurisdiction, and new theory.

I've read many of the chapters and think this is a very important contribution to the literature. I commend it highly to lawyers, judges, corporate governance professionals, and others interested in both law and policy in this area.

Defending director primacy from the Arrowian Moment Critique

In a recent law review article (35 Seattle U. L. Rev. 1033), Matt Bodie compliments my director primacy theory for having "move[d] the ball significantly when it comes to our conceptions of the modern corporation" and for having "been influential in academic, practitioner, and judicial circles." He notes, however, that:

Bainbridge fails to flesh out his theory sufficiently to justify the near absolute control he provides to the board. He repeatedly relies on Arrow's contrast between consensus and authority to resolve any questions of power allocation in favor of stronger authority. This move--characterized by Brett McDonnell as Bainbridge's “Arrowian moment”--is the crux of his model. But as McDonnell points out, Arrow's description of the tradeoff between authority and accountability does not resolve all policy questions in favor of authority. Ultimately, Arrow's dichotomy--and by extension, the director primacy model--is “not able to tell us whether reform in favor of somewhat more accountability at the expense of some, but far from total, loss in authority is a good idea or not.”

I responded to the "Arrowian moment" critique in a paper entitled, simply enough, Director Primacy, which appears in Research Handbook on the Economics of Corporate Law. In it, I argue that:

Critics of the director primacy model sometimes suggest that it overstates the importance of authority. Brett McDonnell (2009, 143), for example, argues that “Bainbridge moves very, very quickly from recognizing the tension between authority and accountability to arguing that we should presume a legal structure that favors authority over accountability, unless there are strong arguments against that presumption.” Apropos the discussion in the preceding section, however, I contend that the utility of director primacy is confirmed by its ability to explain one of the truly striking things about U.S. corporation law; namely, the extent to which the balance between authority and accountability in fact leans towards the former. As we’ve seen, for example, a host of rules serve to limit the power of shareholders vis-à-vis directors. As we’ve also just seen, the business judgment rule is designed precisely “to protect and promote the full and free exercise of the managerial power granted to Delaware directors.”^[1]

In the closely related context of the procedural rules governing shareholder derivative litigation, the New York Court Appeals stated in Marx v. Akers that “By their very nature, shareholder derivative actions infringe upon the managerial discretion of corporate boards.... Consequently, we have historically been reluctant to permit shareholder derivative suits, noting that the power of courts to direct the management of a corporation’s affairs should be ‘exercised with restraint.’”^[2] The Marx court further noted the need to strike “a balance between preserving the discretion of directors to manage a corporation without undue interference, through the demand requirement, and permitting shareholders to bring claims on behalf of the corporation when it is evident that directors will wrongfully refuse to bring such claims,” which is precisely the balance between authority and accountability the director primacy model predicts.

We observe similar rules seemingly designed to protect the board’s authority in statutory provisions, such as those governing transactions in which the directors are personally interested, including management buyouts, which involve a significant conflict of interest and therefore tend to get close judicial scrutiny, but which receive judicial deference in appropriate cases. (Bainbridge 1993, 1074-81) The same is true for the similar problem of target board of director resistance to unsolicited takeover bids. (Bainbridge 2008b)

On the other hand, I have never claimed that the board should have unfettered authority. In some cases, accountability concerns become some pronounced as to trump the general need for deference to the board’s authority. Once again, I turn to Arrow (1974, 78):

To maintain the value of authority, it would appear that [accountability] must be intermittent. This could be periodic; it could take the form of “management by exception,” in which authority and its decisions are reviewed only when performance is sufficiently degraded from expectations ....

Given the significant virtues of discretion, however, I continue to believe that one must not lightly interfere with the board’s decision-making authority in the name of accountability.

McDonnell (2008, 143) contends that this argument proves too much when applied to real world problems, however:

The argument that Bainbridge borrows from Arrow only tells us that there is a trade-off between authority and accountability, and that both have real value. It also tells us that it will generally be unwise to choose a structure that eliminates authority completely in favor of accountability, or vice versa. None of the major pro-accountability reform proposals currently in play, however, comes even close to eliminating board authority. In the world in which we live today, Arrow's argument is not able to tell us whether reform in favor of somewhat more accountability at the expense of some, but far from a total, loss in authority is a good idea or not.

... I have never denied that the argument McDonnell (2009, 143) calls my “Arrowian moment” doesn't do much more than establish a general presumption in favor of respecting director authority.[3] Each doctrinal problem must be carefully analyzed to determine where to strike the balance between authority and accountability. The necessary analysis typically requires one to go beyond the “Arrowian moment” to consider other policies. Hence, for example, my analysis of the business judgment rule acknowledged that:

Critics of the [Arrowian moment] likely would concede that judicial review shifts some power to decide to judges, but contend that that observation is normatively insufficient. To be sure, they might posit, centralized decision making is an essential feature of the corporation. Judicial review could serve as a redundant control on board decision making, however, without displacing the board as the primary decision maker. (Bainbridge 2008, 114)

To explain why the presumption in favor of authority prevails in this context, accordingly, I moved on to consider other policies, such as encouraging risk taking, preventing hindsight bias, and so on.

Similarly, I acknowledge that it’s not enough to point out that proposals to change the shareholder voting process would shift the balance towards accountability. One must go on to ask why such a shift is undesirable (or, preferably, to defend the presumption against such a shift). Hence, in Bainbridge (2008, chap. 5), for example, I went on to consider such questions as whether the shareholders would use the powers activists propose to give them, whether certain shareholders are more likely to do so than others, and whether those shareholders are likely to use their new powers to pursue private gains at the expense of other shareholders.

In sum, director primacy sets the stage. It defines the parameters within which the debate over particular issues takes place. It enables one to make broad predictions about the law and foundational critiques of legal rules that depart from those predictions. The fact that specific problems sometimes require additional fine tuning is hardly proof that the basic model is flawed.

Having made that concession, however, I must immediately recall, by way of analogy, recall Benjamin Cardozo’s famous dictum that the legal duties of a fiduciary should not be undermined by “the ‘disintegrating erosion’ of particular exceptions.”[4] Just so, if one believes that authority has survival value, one should protect the board of directors’ decision-making authority from the “disintegrating erosion” of reform.

This does not mean that one should always reject reforms that shift the balance towards accountability. It does, however, suggest one must pay attention to the cumulative impact of repeated reform proposals, lest one subject the board’s authority to the legal equivalent of death by a thousand cuts. It also suggests that there ought to be at least a presumption in favor of authority. In light of the huge advantages authority offers the corporate form, the burden of rebutting that presumption should be on those who wish to constrain the board’s authority.

---

[1] Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985).

[2] Mark v. Akers, 666 N.E.2d 1034, 1037 (N.Y. 1996) (quoting Gordon v. Elliman, 119 N.E.2d 331, 335 (N.Y. 1954)); see also Pogostin v. Rice, 480 A.2d 619, 624 (Del. 1984) (“[T]he derivative action impinges on the managerial freedom of directors ....”).

[3] As we have just seen, however, such a presumption has considerable explanatory value when one reviews the many corporate law doctrines that enshrine deference to boards. If one grants my starting hypothesis that corporate law tends towards efficient solutions, those doctrines are persuasive evidence for director primacy.

[4] Meinhard v. Salmon, 249 N.Y. 458, (N.Y. 1928).

On Why Radio Today re "Are Corporations People?"

WHY? Radio presents: "Are Corporations People?” with guest Stephen M. Bainbridge.

Sunday, June 10, 5 p.m. central.

Listen live from anywhere in the world at www.whyradioshow.org  and in North Dakota at 89.3 (Grand Forks),  91.9 (Fargo), 90.5 (Bismarck), and on Prairie Public radio stations across North Dakota.

 RSVP on Facebook at:  https://www.facebook.com/events/322982607777391/

In 2010, the U.S. Supreme Court ruled that corporations should be considered persons. They have the same rights as individuals, including the freedom to fund political campaigns. This led to a firestorm of debate with advocates arguing both sides, each pointing to the absolute necessity of their positions. On this episode of WHY?, we will ask what it means for a corporation to be a person, how collective action affects agency, and how these large companies are to be considered legally and morally accountable for their actions.

Stephen Bainbridge is the William D. Warren Distinguished Professor of Law at the UCLA School of Law in Los Angeles. He is a prolific scholar, whose work covers avariety of subjects, but with a strong emphasis on the law and economics ofpublic corporations. He has written over 75 law review articles and numerous books. He has been a Salvatori Fellow with the Heritage Foundation and in 2008 and 2011, he was named by Directorship magazine to its list of the 100 most influential people in the field of corporate governance.

Upcoming radio event: Are Corporations People?

This may be of interest:

WHY? Radio presents: "Are Corporations People?” with guest Stephen M. Bainbridge.

Sunday, June 10, 5 p.m. central.

Listen live from anywhere in the world at www.whyradioshow.org  and in North Dakota at 89.3 (Grand Forks),  91.9 (Fargo), 90.5 (Bismarck), and on Prairie Public radio stations across North Dakota.

 RSVP on Facebook at:  https://www.facebook.com/events/322982607777391/

In 2010, the U.S. Supreme Court ruled that corporations should be considered persons. They have the same rights as individuals, including the freedom to fund political campaigns. This led to a firestorm of debate with advocates arguing both sides, each pointing to the absolute necessity of their positions. On this episode of WHY?, we will ask what it means for a corporation to be a person, how collective action affects agency, and how these large companies are to be considered legally and morally accountable for their actions.

Stephen Bainbridge is the William D. Warren Distinguished Professor of Law at the UCLA School of Law in Los Angeles. He is a prolific scholar, whose work covers avariety of subjects, but with a strong emphasis on the law and economics ofpublic corporations. He has written over 75 law review articles and numerous books. He has been a Salvatori Fellow with the Heritage Foundation and in 2008, he was named by Directorship magazine to its list of the 100 most influential people in the field of corporate governance.

Stephen's blog can be found at: http://www.professorbainbridge.com/

Guns versus at will employment

My friend and colleague Eugene Volokh blogs that:

Kentucky Employees May Not Be Fired for Lawfully Storing Guns in Their Cars

That’s what Kentucky statutes provide, and today the Kentucky Supreme Court applied this rule in Mitchell v. University of Kentucky (Ky. Apr. 26, 2012). There was something of a complication because the defendant was a university, and state law provides universities with generally broad authority to restrict weapons on their property. But the court concluded that the statutory provisions allowing employees to lawfully store guns in their cars is an exception from that broad university power.

As Clayton Cramer explains, the Mitchell case "ruled that an employee and grad student who was fired from his job for having a handgun in his car (for which he had a concealed handgun license) has a valid basis for a wrongful termination suit against the university.  It's a complicated discussion, but the core of the argument is that Mitchell was exercising his right to keep and bear arms in conformity with Kentucky law.  While the university has some authority to regulate possession of arms on university property, when those regulations are in conflict with public policy, as defined by the state legislature, the university's rules lose the fight."

I'm not a Second Amendment enthusiast, but set that issue aside. What bugs me about cases like this is the implications for the doctrine of at-will employment. Cases like this illustrate that both right and left are willing to throw at-will employment under the bus to advance policy goals. In contrast, I think at-will employment (except, of course, for tenured law professors ) is a crucial social policy that deserves better from those of us on the right who respect free enterprise and free markets.

The economic effects of "public policy"-based exceptions to the at-will employment doctrine are well-established.

There are predictable economic effects associated with the increasing acceptance of the wrongful-termination doctrine. In effect, it creates for workers some degree of property right in their existing jobs. These additional rights tend to increase the costs to employers of hiring labor. For example, the potential threat of legal action resulting in liability awards to aggrieved employees now becomes a part of the cost calculus that employers must make when considering the hiring of new workers. Also, the threat of such actions by employees makes it more difficult for employers to adjust their usage of labor in an efficient manner to fit changing market conditions. To a certain extent, the labor input into the productive process no longer can be treated as a variable input. Rather, it has acquired some of the characteristics of a fixed input.

The presence of additional labor costs associated with the employment relationship requires a response by employers. There are two options open to them. One is through changes in the level of workers' compensation. Added labor costs perceived by those who hire labor may be passed on to employees by downward adjustments in labor compensation. The other possibility is to reduce the number of workers hired. The mix of these two options will depend on the nature of the elasticities of demand for and supply of labor. This is spelled out in the Technical Appendix. Using what we view as a reasonable set of these elasticities, also described in the Technical Appendix, it appears that about 85 percent of any additional labor cost arising out of the emergence of the wrongful-termination doctrine will be passed on to employees in the form of reduced wages and benefits for workers. The remainder represents what can be thought of as "net uncompensated costs" to the employer and will negatively affect the willingness of employers to hire workers. ...

Lawyers, labor unions, and other groups have successfully sought changes in the legal environment in which business operates to subvert the sanctity of private contracts, particularly the ancient doctrine of employment-at-will. In a sense, these developments are a form of stealth taxation. They have imposed very significant and real burdens on the American people. ... This is stealth taxation because it is a burden that was not imposed in a manner that was clear and open to the taxpayers. Legislatures did not in a single historic vote decide to radically revise our system of contracts and property rights. Moreover, it is highly regressive taxation, falling heavily on the poor and disadvantaged. (Link)

Another paper summarizes the reasons this form of stealth taxation is highly inefficient:

Employment-at-will dominated other potential terms of exchange because it was efficient. If an employee can be dismissed at any time and for any reason, then said employee has every reason to be productive. Productive employees have little to fear from arbitrary dismissal, since profit-seeking employers can only hurt themselves by dismissing them. Even today, employment-at-will is embraced and long-term contracts avoided in most cases outside of union and government employment.

If at-will contracts are not the best arrangement for those involved, the parties are always free to modify their agreement to mutual advantage. Transaction costs between the two parties are extremely low, and advocates of intervention have never been able to document any substantial third-party effects that justify interference on efficiency grounds. The at-will contract allows more-or-less continuous minor adjustments of contract terms in any direction on a mutually agreeable basis. The arrangement is self-enforcing because a mix of formal and informal controls link payments to employee value and effort rendered. The arrangement avoids the problems inherent in explicit contract language and its inevitable unforeseen gaps, as well as the incentive deficiencies and shirking problems accompanying a fixed duration of employment. While average U.S. job tenure is eight years, it is voluntary markets, not unjust dismissal laws, that sustain such relations. (Link)

You might say, "well, this is just a little exception to at will employment and it protects Constitutional rights." If so, you would be wrong. It would take a remarkably extremist understanding of the Second Amendment to believe that one has a Constitutional right to possess firearms on your employer's property.

In any case, it is the steady erosion of carving out one "little exception" to the at will doctrine after another that has essentially eviscerated that doctrine.

The new public policy doctrines prohibit employers from dismissing employees for performing acts protected by public policy or for declining to commit acts prohibited by public policy. While the public policy exceptions may be the least controversial incursions against at-will employment, problems with these exceptions abound. The term "public policy" evades precise and uniform definition. Can an exception be declared by legislative action only? Or can it emanate from judicial and other sources? The open-ended nature of public policy exceptions is typified by the California court that in Peterman v. Local 396 (1959) declared that anything that contravenes "good morals or any established interests of society" constitutes action against public policy. SincePalmattere v. International Harvester (1981), Illinois courts have expansively defined public policy as "that which is right and just and collectively affects the state’s citizenry." And in Nees v. Hocks (1975), an Oregon court declared that an employer can be held responsible for dismissing an employee "for a socially undesirable motive."

From an economic point of view, a public policy prohibition on dismissal might have an efficiency rationale based on third-party effects. Consider a relatively uncontroversial example: no dismissal for employee absence due to jury duty. The rationale behind these laws is that jury service is a public service, public good, or externality-rich action that allegedly serves the general interest. But even if this proposition is accepted, the cost is not spread across the entire community; rather, it is forced on the juror-employee and his firm’s owners. The tax, or "taking," in other words, is suffered by the absent employee and the unlucky business owners who might otherwise have replaced that employee. The cost of jury duty has been arbitrarily externalized by the courts, legislature, and general public. (Link)

In sum, I don't care whether the guy got fired for having a gun in his car or for [insert here a politically incorrect reason that would have some hyper-sensitive, far-left UCLA law student with no sense of humor running off to once again call on the Dean and Chancellor to fire me for daring to exercise my free speech rights ... not that I'm bitter or anything]. Whether it's a policy preference of right or left, only truly fundamental social goals like ending race discimination ought to trump the principle of at-will employment.

The case for A FCPA

I'm dubious that THE Foreign Corrupt Practices Act, as it stands on the books today, is a particularly wise statute. Among the many cogent criticisms that have been lodged against the FCPA are the following:

•  It seems clear that Congress intended to exempt so-called facilitation payments (such a slipping a few bucks to a customs official to keep your shipment of perishable products from rotting in the sun on a loading dock, but the current law is unclear and unworkable, which has allowed the DoJ to start cracking down on such payments.
• The definition of who constitutes a foreign official is unclear and unworkable. Parties thus are unsure whether paying, e.g., an agent of a state-owned corporation is a violation.
• The penalties are unduly harsh relative to the harms associated with the conduct.
• Vague rules coupled with high penalties encourage firms to settle cases that lack real merit.
• The government claims that voluntary disclosure of an internal investigation will lead to lower sanctions, but many commentators believe that the government in fact does not mitigate sanctions in response to voluntary disclosure.
• US corporations (and foreign issuers subject to US jurisdiction) face a more vigorously enforced statute with higher penalties than do firms based in some of our major global competitors, which puts our firms at a competitive disadvantage.
• Imposition of US business ethics on officials of foreign countries represent neo-colonial insensitivity to cultural values and an intrusion on foreign nation's sovereignty.
• The FCPA has been far more successful at chilling legitimate conduct than deterring intentional misconduct. As a result, honest firms are burdened, while dishonest ones go free.

Having said all that, however, I believe that there is a case to be made for A FCPA. As the OECD has observed in connection with its anti-bribery convention:

Bribes to high-level officials for government contracts, such as for defence contracts, infrastructure projects, and oil and gas concessions, can result in the plundering of national assets, and endemic “confusion” between private and public funds in some developing and transition economies.

Foreign bribery distorts international competitive conditions and denies companies the ideal “level playing field” on which to do business. The OECD is leading global efforts to level this playing field for international business by fighting to eliminate bribery of foreign public officials from the competition for contracts and investment.

Corruption in awarding business contracts exacts social, political, environmental and economic costs that no country can afford. If public officials take bribes when awarding contracts to foreign businesses for public services such as roads, water or electricity, serious consequences result: prices are inflated, allocation of resources is distorted, foreign investment becomes less appealing, and competition is undermined. The effects on investment, growth and development are devastating. 

 As Elizabeth Spahn has demonstrated, moreover, bribery is not a victimless crime (41 GEOJIL 861):

Modern economic research reveals that while bribery may facilitate an isolated transaction, when examined over a longer timeframe bribery provides market incentives to increase regulations. Bilateral monopolies of insiders (business and government), misnamed crony ‘capitalism,’ use their relationships to restrict market access and harass competitors, reducing actual market-based competition. ‘Friendly’ regulatory environments, reducing regulatory burdens for bribe-paying insiders, erode safety regulations and distract business from tending to safety and quality control, focusing business efforts instead on developing relationships with powerful officials. The longer timeframe reveals an eco-cycle of regulations, bribery and deteriorating safety/quality control.

As a business transaction from the micro-economic viewpoint, bribery is a high-risk business model. [She] provides specific examples of various risk-points in a bribe-transaction, including unreliability of corrupted partners and intermediaries, difficulties establishing fair prices for bribes, and very risky exit strategies. Where entire cultures tolerating bribery arise, modern scholarship reveals opportunistic penetration by transnational organized criminal syndicates.

It strikes me that the solution is a multi-national treaty among the members of the OECD and G-20, in which a workable set of global rules are developed to ensure that all firms compete on a level playing field. In addition to harmonized rules, you'd need some sort of mechanism for sanctioning countries that fail to achieve some agreed level of enforcement efforts.

Is the corporation an entity? With application to the SCOTUS

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.