I'm on sabbatical this fall, writing a book entitled "Director Primacy: The Theory and Practice of the New Corporate Governance," which obviously builds on my law review articles on director primacy. Over the weekend, I was working on drafting a short summation of what Director Primacy is all about. Here's what I came up with:
Let's review. The corporation is properly understood to be a legal fiction representing a web of contracts among multiple classes of stakeholders. As such, the law’s principal function with respect to corporate governance is facilitating private ordering by providing a set of off-the-rack default rules. While the parties appropriately remain free to modify those rules as they see fit, the default rules should be designed to minimize transaction costs. In most cases, doing so means selecting the majoritarian default as the legal rule; i.e., the rule most people would select if they could costlessly bargain with one another.
There is good reason to think that the default rules of corporate law are generally efficient. Even if one thinks long-term survival is inadmissible evidence of a rule’s merits, the evidence that state competition for charters results in a race to the top suggests that corporate law rules generally tend to evolve towards the majoritarian default.
In every state, the default rule calls for the corporation to be run neither by shareholders nor executives, but by a board of directors elected by the shareholders and responsible for maximizing shareholder wealth. Since I assume that this separation of ownership and control is a majoritarian default validated both by its long survival and the race to the top, it was necessary to develop a theory as to why this was the governance structure most corporate stakeholders would select if they could have costlessly bargained over the issue when the corporation was being formed.
The size and complexity of the public corporation ensures that stakeholders face significant collective action problems in making decisions, suffer from intractable information asymmetries, and have differing interests. Under such conditions, consensus-based decision-making structures are likely to fail. Instead, it is cheaper and more convenient to assign the decision-making function to a central decision-maker wielding the power to rewrite most intra-corporate contracts by fiat.
The analysis to this point, of course, suggests only that the decision-making structure should be one based on authority rather than participatory democracy. Yet, it turns out that corporate law was wise to assign decision-making authority to a group rather than a single individual. Groups turn out to have significant advantages vis-à-vis individuals at exercising critical evaluative judgment, which is precisely the skill set principally needed at the top of the corporate hierarchy. In addition, groups solve the problem of “who watches the watchers” by placing a self-monitoring body at the apex of the corporate hierarchy. We thus have a rather compelling story explaining why the default rules of corporate governance envision a system of director primacy.
There is much that is contestable in that brief summary, of course, all of which will be defended in the book. In addition, this passage deals only with the normative aspects of the problem. It remains to be seen whether I can build a persuasive account that director primacy has real world descriptive power. Stay tuned.
