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.[1] In turn, the corporation’s interests are defined as the “joint welfare function” of all constituents who make firm specific investments.[2] 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.[3] 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.[4] In contrast, Blair and Stout believe that corporate directors do take such interests into account and the current law is adequate in this regard.[5]
A. The Firm as Team
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.[6] 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 ....”[7] 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.”[8]
Building on the work of Rajan and Zingales, Blair and Stout define team production by reference to firm specific investments.[9] Hence, for example, they describe the firm “as a ‘nexus of firm-specific investments.’”[10] 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.[11] 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.[12] Even the board of directors can be regarded as a relational team.[13] 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.[14] 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.[15] Accordingly, the concept of team production is simply inapt with respect to the large public corporations with which Blair and Stout are concerned. [16]
B. The Domain of the Mediating Hierarchy
John Coates argues that Blair and Stout’s mediating hierarch model fares poorly whenever there is a dominant shareholder.[17] 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.[18] 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.[19] Even where a majority of the board is nominally independent, the board may be captured by insiders.[20]
I more skeptical than Coates of board capture theories, having argued elsewhere that independent board members have substantial incentives to buck management.[21] On balance, however, Coates makes a persuasive case that the mediating hierarch model has a relatively small domain.[22] In contrast, the domain of director primacy, which merely requires the absence of a controlling shareholder, seems considerably larger.
C. The Foundational Hypothetical
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.[23] 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.[24] 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.[25]
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.[26] Yet, even in that setting, the model seems inapt. In the typical pattern, the entrepreneurial founders hire the first factors of production.[27] If the firm subsequently goes public,[28] the founding entrepreneurs commonly are replaced by a more or less independent board.[29] 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.[30]
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.[31] The board of directors as an institution thus pre-dates the rise of shareholder capitalism.[32] When the earliest industrial corporations began, moreover, they typically were large enterprises requiring centralized management.[33] Hence, separation of ownership and control was not a late development but rather a key institutional characteristic of the corporate form from its inception.[34] 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.
D. The Board’s Role
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.”[35] In other words, the principal function of the mediating board is resolving disputes among other corporate constituents.[36] 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:[37] 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.[38] 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.[39] 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.”[40] 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.[41]
If directors suddenly began behaving as mediating hierarchs, rather than shareholder wealth maximizers, an adaptive response would be called forth.[42] Consistent with the predictions developed above,[43] 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.
E. A Doctrinal Test: The Business Judgment Rule
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,[44] 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.[45] 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.[46] 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.[47] 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.[48] The case law, properly understood, does not stand for the proposition that directors have discretion to make trade-offs between nonshareholder and shareholder interests.[49] 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.[50]
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.[51] 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.[52]
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.[53] 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.”[54]
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.[55] 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.[56]
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.[57] 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.[58] 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.[59] 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,[60] because they would conclude that the systemic costs of judicial review exceed the benefits of punishing director misfeasance and malfeasance.[61]
[1] Blair & Stout, supra note 18, at 288. [Ed.: Note that I have not bothered to correct the jump cites.] The mediating hierarch model resembles Lynne Dallas’ theory of the relational board, which “assist[s] the corporation in forging relationships with various stakeholders and others in its social environment.” Lynne L. Dallas, The Relational Board: Three Theories of Corporate Boards of Directors, 22 J. Corp. L. 1, 3 (1996). It also resembles Larry Mitchell’s proposal to “to recast the board of directors as a mediating body among the different corporate constituent groups.” Lawrence E. Mitchell, A Critical Look at Corporate Governance, 45 Vand. L. Rev. 1263, 1272 (1992).
[2] Blair & Stout, supra note 18, at 288. This aspect of Blair and Stout’s argument is similar to the claim advanced by Thomas Smith in a provocative recent article. Smith contends that the correct governing norm for corporate decisionmaking is one obliging the board to maximize the value all the financial claims the corporation has issued. Smith, supra note 163, at 217-18. Smith’s argument is based in the first instance on an assumption that investors (and, presumably, managers) are rational. Id. at 239-42. To the extent one assumes rationality is bounded, however, a simpler norm—maximize share value rather than the aggregate value of all financial claims—may be desirable. Cf. Richard A. Booth, Stockholders, Stakeholders, and Bagholders (or How Investor Diversification Affects Fiduciary Duty), 53 Bus. Law. 429 (1998) (arguing that corporate fiduciary duties should not be defined by the reference to rational diversified investors, in part because managers cannot know what policies such investors would prefer). In any case, Smith assumes that rational investors invest across a wide array of assets and therefore would prefer a rule requiring that “managers should make the choice that will maximize the value of rational investors’ diversified portfolios.” Smith, supra note 163, at 242. Yet, to the extent we have evidence as to the preferences of actual investors, those investors appear to prefer a rule of share value maximization. The Council of Institutional Investor’s corporate governance policy states, for example, calls for “governance structures and practices” that “protect and enhance accountability to, and equal financial treatment of, shareholders. An action should not be taken if its purpose is to reduce accountability to shareholders.” Council of Institutional Investors, Corporate Governance Policies, at http://www.cii.org/corp_ governance.htm (emphasis supplied). Similarly, Lens Investment Management LLC’s policy statement refers to its desire to “to maximize shareholder values.” Lens Investment Management LLC, Statement of Policy, at http://www.lens-inc.com/lenspolicy.html (emphasis supplied). Finally, Smith does not resolve the two masters problem. In other words, when managers are confronted with a zero-sum situation requiring them to make trade-offs between various claims, which claim do they prefer? Cf. Katz v. Oak Indus., Inc., 508 A.2d 873, 879 (Del. Ch. 1986) (holding that a corporation’s board is obliged to maximize shareholder interests, even if doing so is adverse to the interests of debenture holders).
[3] Blair & Stout, supra note 18, at 286.
[4] Id. at 286 n.83.
[5] See id. at 286 nn.82-83 (discussing nonshareholder constituency literature).
[6] See id. at 269 (stating: “we argue that shareholders, executives, and employees are all team members”; emphasis in the original).
[7] Susan G. Cohen and Diane E. Bailey, What Makes Teams Work: Group Effectiveness Research from the Shop Floor to the Executive Suite, 23 J. Mgmt. 239, 241 (1997).
[8] Kenneth L. Bettenhausen, Five Years of Groups Research: What have we Learned and What Needs to be Addressed?, 17 J. Mgmt. 345, 346 (1991)
[9] See id. at 271-73 (discussing Raghuram G. Rajan & Luigi Zingales, Power in the Theory of the Firm, 113 Q. J. Econ. 387 (1998)). Of course, many corporate constituents invest little in firm specific capital (human or otherwise), but this is mere quibbling. See supra text accompanying note 155. Conversely, David Millon criticizes Blair and Stout on the ground that shareholders are the corporate constituency least likely to make firm specific investments. David Millon, New Game Plan or Business as Usual? A Critique of the Team Production Model of Corporate Law, 86 Va. L. Rev. 1001, 1007 n.15 (2000). In my view, Millon’s position both overstates the extent to which nonshareholder constituencies make firm specific investments and understates the extent to which shareholders do so. See supra notes 154-160 and accompanying text (discussing relative investments in firm specific assets by corporate constituencies).
[10] Blair & Stout, supra note 18, at 275.
[11] See Williamson, supra note 35, at 244-47 (discussing team production as a function of task separability and asset specificity).
[12] See Bainbridge, supra note 41, at 1018-20 (describing self-directed work teams).
[13] See Bainbridge, supra note 52, at ___.
[14] See Bainbridge, supra note 41, at 1042-44 (applying Williamson’s analysis to production teams).
[15] The canonical example of task nonseparability in a team production setting was developed by Alchian and Demsetz, who hypothesized two workers jointly lifting 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. Hence, the need for monitoring. Alchian & Demsetz, supra note 39, at 779-80. In order for an activity to be task nonseparable, it must be impossible (or very costly) to measure individual marginal productivity. See Williamson, supra note 35, at 244. Is it useful to think of shareholders and creditors as part of a production team? If so, is it impossible to measure their marginal contributions to firm productivity? Firms can readily determine their respective equity and debt costs of capital, which seems a reasonable proxy for measuring the value of (and thus the contribution of) financial inputs. Cf. Richard A. Brealey & Stewart C. Myers, Principles of Corporate Governance 543-46 (6th ed.2000) (discussing calculation of the weighted average cost of capital). The effort firms devote to tweaking their capital structure when making financing decisions also suggests an ability to separate the relative contributions of creditors and equity investors. Cf. id. at 528 (concluding that “capital structure matters”).
[16] The objection is important, although not fatal to Blair and Stout’s project. In my view, they could defend the mediating hierarch model without using team production concepts at all. Instead, as I see it, the team production model serves them largely as a rhetorical device to establish a favorable setting in which the mediating hierarch concept seemingly follows as a matter of course.
[17] See Coates, supra note 96, at 840-42 (discussing ways the mediating hierarch model fails to explain such firms).
[18] Id. at 843.
[19] Id. at 844-45.
[20] Id. at 845-46.
[21] See supra note 59 and accompanying text (describing argument).
[22] In a forthcoming article, Blair and Stout retort that the domain may be small when measured by number of firms, but not when measured by the asset value of those firms. Margaret M. Blair & Lynn A. Stout, Director Accountability and the Mediating Role of the Corporate Board, __ Wash. U.L.Q. ___ (2001).
[23] See Blair & Stout, supra note 18, at 275-76.
[24] Id. at 277.
[25] See id. at 278 (arguing that “shareholders, employees, and perhaps other stakeholders such as creditors or the local community ... enter into this mutual agreement in an effort to reduce wasteful shirking and rent-seeking by relegating to the internal hierarchy the right to determine the division of duties and resources in the joint enterprise.”). Blair and Stout’s model assumes that “the likely economic losses to a productive team from unconstrained shirking and rent-seeking are great enough to outweigh the likely economic losses from turning over decisionmaking power to a less-than-perfectly-faithful hierarch.” Id. at 284. As yet, however, we lack empirical evidence that corporate constituents make such trade-offs and, if so, that the trade-off leans in the predicted direction.
[26] Given the vast media attention devoted to start-ups during the late 1990s, they admittedly made a seductive target for scholarly inquiry. See, e.g., Gulati et al., supra note 24, at 896-97 (discussing Internet start-ups and virtual firms). Query, however, whether such firms tell us much about the governance of established public corporations. Ironically, the paradigmatic late 1990s start-up—dot-com firms—had notoriously severe corporate governance problems, which may been a contributing factor in their recent economic problems. See, e.g., Peter Buxbaum, The Trouble with Dot-Com Boards, Chief Executive, Oct. 1, 2000, at 50.
[27] Equity capital may be the principal exception. In many respects, it is more accurate to say that venture capitalists hire entrepreneurs than vice-versa. At the very least, the two must collaborate closely. See Daniel M. Cable & Scott Shane, A Prisoner’s Dilemma Approach to Entrepreneur-Venture Capitalist Relationships, 22 Acad. Mgmt. Rev. 142 (1997); D. Gordon Smith, Team Production in Venture Capital Investing, 24 J. Corp. L. 949, 960 (1999).
[28] Blair and Stout suggest that the decision of such promoters to subsequently go public “may be driven in part by team production considerations.” Blair & Stout, supra note 18, at 281. It seems more likely that the decision to go public is driven either by a need for additional equity financing or, even more likely, by the desire to cash out some portion of the founder’s stock (i.e., to get rich). See generally Richard A. Booth, The Limited Liability Company and the Search For a Bright Line Between Corporations and Partnerships, 32 Wake Forest L. Rev. 79, 89-92 (1977) (evaluating motives for going public).
[29] See Sam Allgood & Kathleen A. Farrell, The Effect of CEO Tenure on the Relation Between Firm Performance and Turnover, 23 J. Fin. Res. 373 (2000) (reporting “it appears founders are initially entrenched, but lose control of their board of directors later in their tenure”).
[30] This empirical claim is consistent with the legal architecture of corporate formation. As envisioned by the statute, the corporation is formed by incorporators. Model Bus Corp. Act Ann. § 2.01 (1997). The corporation comes into existence when the articles of incorporation are accepted by the Secretary of State. Id. § 2.03(a). If the initial directors are named in the articles, they are required to hold an organizational meeting at which, inter alia, officers are named. Id. § 2.05(a)(1). If not, the incorporators conduct the organizational meeting. Id. § 2.05(a)(2). Instructively, the statutory scheme thus contemplates that the board of directors pre-dates other corporate constituencies. In practice, of course, promoters will make contracts with many factors of production before the corporation is formed. See id. § 2.04 (imposing joint and several liability on promoters for preincorporation contracts).
[31] See II John P. Davis, Corporations: A Study of the Origin and Development of Great Business Corporations and of their Relation to the Authority of the State 217 (1905) (stating: “In the beginning the germ of the future conception of a corporation made its way into the English law through the recognition of the ‘communities’ of cities and towns, and of the body of rights and duties appertaining to residence in them.”); see also id. at 222 (noting the contributions of ecclesiastical corporations and guilds to the evolving corporate form).
[32] Cf. Ronald E. Seavoy, The Origins of the American Business Corporation: 1784-1855 10 (1982) (discussing the emergence and role of the board of trustees of colonial ecclesiastical corporations).
[33] Id. at 4-5.
[34] See Walter Werner, Corporation Law in Search of its Future, 81 Colum. L. Rev. 1611, 1629-44 (1981) (discussing the separation of ownership and control in historical context).
[35] Blair & Stout, supra note 18, at 281.
[36] See id. at 284 (comparing directors to “the referee in a the football game”).
[37] The following tracks the taxonomy suggested by Johnson et al., who map “directors responsibilities into three broadly defined roles ... labeled control, service, and resource dependence.” Jonathan L. Johnson et al., Boards of Directors: A Review and Research Agenda, 22 J. Mgmt. 409, 411 (1996).
[38] Id. at 428 (summarizing studies).
[39] See Williamson, supra note 67, at 176-77 (discussing the organizational concerns of transaction cost economics).
[40] Id. at 175.
[41] See supra notes 135-141 and accompanying text (discussing how board incentives are aligned with shareholder interests). Blair and Stout posit that the legal mechanisms purporting to ensure director accountability to shareholder interests—such as derivative litigation and voting rights—benefit all corporate constituents. Blair & Stout, supra note 18, at 289. See also id. at 313 (asserting that shareholders’ self-interested exercise of voting rights can “serve the interest of other stakeholders in the firm as well”). Conceding that shareholder and nonshareholder interests are often congruent, it nevertheless remains the case that some situations present zero-sum games. Further conceding the weakness of those accountability mechanisms, shareholder standing to pursue litigation and/or the exercise of shareholder voting rights nevertheless give shareholders rights that potentially can be used to the disadvantage of other constituencies.
[42] Director motivation is a question that plagues all three models of the board. Under shareholder primacy, why would directors accept a role in which they expend effort to maximize the wealth of others? Under the mediating hierarch approach, why would directors be willing to serve as referees? Under director primacy, why would directors want to hire factors of production and exercise fiat? If the directors are the residual claimants, of course, the answer is obvious—they are motivated by self-interest in the value of their claim. Once ownership of the residual claim is separated from decisionmaking power, however, we require a more robust theory of director motive.
[43] See supra notes 135-141 and accompanying text.
[44] See Milton Friedman, The Methodology of Positive Economics, in Essays in Positive Economics 23, 27 (1985).
[45] For a more extensive analysis of Blair and Stout’s doctrinal claims, see Millon, supra note 186, at 1009-20.
[46] See infra text accompanying note 229 (quoting Smith v. Van Gorkom, 488 A.2d 858, 872(Del. 1985)). Two conceptions of the business judgment rule compete in the case law. One treats the rule as having substantive content. In this version, the business judgment rule comes into play only after one has first determined that the directors satisfied some standard of conduct. See, e.g., Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 360 (Del. 1993) (holding that plaintiffs rebut the business judgment rule’s presumption of good faith by “providing evidence that directors, in reaching their challenged decision, breached any one of the triads of their fiduciary duty—good faith, loyalty or due care”). Alternatively, the business judgment rule is seen as an abstention doctrine. Under this version, the court will abstain from reviewing the substantive merits of the directors’ conduct unless the plaintiff can rebut the business judgment rule’s presumption of good faith. See, e.g., Shlensky v. Wrigley, 237 N.E.2d 776, 779 (Ill. App. 1968) (holding that: “In a purely business corporation ... the authority of the directors in the conduct of the business of the corporation must be regarded as absolute when they act within the law, and the court is without authority to substitute its judgment for that of the directors.”). Explaining the doctrinal and policy superiority of the latter conception is one of those tasks best left for another day.
[47] See, e.g., Sinclair Oil Corp. v. Levien, 280 A.2d 717 (Del. 1971) (fiduciary duties of controlling shareholder); Shlensky v. Wrigley, 237 N.E.2d 776 (Ill. App. 1968) (operational decision); Auerbach v. Bennett, 393 N.E.2d 994 (N.Y. 1979) (dismissal of derivative litigation).
[48] See Blair & Stout, supra note 18, at 303 (arguing that the business judgment rule authorizes directors to make trade-offs between shareholder and nonshareholder interests); see also Greenfield and Nilsson, supra note 141, at 831 (arguing that the business judgment rule reflects “an underlying distrust of the strict fiduciary duty to maximize shareholder returns”); Smith, supra note 113, at 286-87 (arguing that the business judgment rule precludes liability where directors fail to maximize shareholder wealth).
[49] For a concise critique of each of the business judgment rule-based opinions on which Blair and Stout relied, see Millon, supra note 186, at 1015-16 n.40.
[50] A few cases can be read to suggest that directors need not treat shareholder wealth maximization as their sole normative objective. Upon close examination, however, most of these cases in fact are not inconsistent with the shareholder wealth maximization norm. See supra 56 (discussing such cases). In Shlensky v. Wrigley, 237 N.E.2d 776 (Ill. App. 1968), for example, a minority shareholder in the Chicago Cubs sued Wrigley, the team’s majority shareholder, over the latter’s famous refusal to install lights at Wrigley Field. Shlensky claimed the decision against lights was motivated by Wrigley’s beliefs that baseball was a day-time sport and that night baseball might have a deteriorating effect on the neighborhood surrounding Wrigley Field. Id. at 778. Despite Shlensky’s apparently uncontested evidence that Wrigley was more concerned with nonshareholder than with shareholder interests, the Illinois Appellate Court dismissed for failure to state a claim upon which relief could be granted. Id. at 778-80. Although this result on superficial examination may appear to devalue shareholder wealth maximization, on close examination the case involves nothing more than a wholly unproblematic application of the business judgment rule. See Bainbridge, supra note 56, at 978-79 (discussing Shlensky). In other words, I concede that the business judgment rule has the effect of insulating the board of directors from liability when they put the interests of nonshareholder constituencies ahead of those of shareholders, but deny that that is the rule’s intent.
[51] 170 N.W. 668, 684 (Mich. 1919). See supra text accompanying note 111 (quoting relevant passage).
[52] Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985).
[53] Cf. Marx v. Akers, 666 N.E.2d 1034, (N.Y. 1996) (noting that “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.’”); see also Pogostin v. Rice, 480 A.2d 619, 624 (noting that “the derivative action impinges on the managerial freedom of directors”)
[54] Compare Dodge, 170 N.W. at 684 with Blair & Stout, supra note 18, at 301-02 (critiquing the Dodge decision).
[55] Blair & Stout, supra note 18, at 746.
[56] Arrow, supra note 40, at 78.
[57] See, e.g., Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (explaining that the rule creates a presumption that the directors or officers of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company).
[58] See, e.g., Kamin v. American Express Co., 383 N.Y.S.2d 807, 811 (N.Y. Sup. 1976) (stating that absent “fraud, dishonesty, or nonfeasance,” the court would not substitute its judgment for that of the directors), aff’d, 387 N.Y.S.2d 993 (N.Y. A.D. 1976).
[59] See, e.g., Joy v. North, 692 F.2d 880, 885 (2d Cir. 1982) (stating: “While it is often stated that corporate directors and officers will be liable for negligence in carrying out their corporate duties, all seem agreed that such a statement is misleading.... Whatever the terminology, the fact is that liability is rarely imposed upon corporate directors or officers simply for bad judgment and this reluctance to impose liability for unsuccessful business decisions has been doctrinally labeled the business judgment rule.”); Brehm v. Eisner, 746 A.2d 244, 262-64 (Del. 2000) (rejecting plaintiff’s contention that the business judgment rule includes an element of “substantive due care” and holding that the business judgment rule requires only “process due care”).
[60] Shareholder primacy-oriented critics of director primacy 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 decisionmaking is an essential feature of the corporation. Judicial review could serve as a redundant control on board decisionmaking, however, without displacing the board as the primary decisionmaker. If made, this argument would reflect the preoccupation with agency costs of law and economics-oriented proponents of shareholder primacy. As noted above, we could eliminate agency costs by eliminating discretion. But we do not. To the contrary, we ensure the board’s power to freely exercise discretion by creating rules that insulate the board from review by courts, shareholders, and nonshareholder constituencies alike. We do this not to allow directors to function as mediating hierarchs, but because it maximizes shareholder wealth.
[61] I plan to develop this claim more fully in a future article.
