A while back I noted that the American Law Institute is going to try writing a Restatement of the Law of Corporate Governance. I was skeptical.
Some thoughts: First, a restatement that applies to both closely held corporations and public corporations is unlikely to be successful. I refer you to my mentor Michael Dooley who argued that:
. . . the participants in a firm must have some governance structure to determine three basic questions. First, what are the general sorts of adaptive decisions that will need to be made over time? Second, what general normative principle guides decision making—that is, for whose benefit are decisions to be made? And, third, who, within the firm, shall make the adaptive decisions?
The answer to the second question is the same for all capitalist firms: decisions are to be made to benefit the interests of the residual claimants because maximizing their wealth necessarily maximizes the wealth of the coalition. The first and third questions are closely related, but their answers differ depending on salient characteristics of the type of firm in question.
In most general partnerships and closely held corporations, there is no functional distinction between management and residual claimants because the same persons perform both functions. Thus, all adaptive decisions, whether routine or extraordinary, are made by the residual claimants. In publicly held corporations, however, management and residual claimants have sharply differentiated functions. This distinction is codified in all corporations statutes by provisions similar to section 8.01(b) of the Revised Model Business Corporation Act: “All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed under the direction of, its board of directors, subject to any limitation set forth in the articles of incorporation.”
The different decision-making structures prescribed for partnerships and closely held corporations, on the one hand, and publicly held corporations, on the other, result only partially from the number of putative decision makers involved in the respective types of firms. The characteristics that primarily dictate the choice of decision-making structure are the similarities in information and interests of the decision makers. Thus, if all partners actively participate in the management of the business, each partner should have (or, at least, be exposed to) the same facts necessary to make adaptive decisions. And since all partners are residual claimants, each has the same interest, namely, increasing the size of the residual interest. Under these conditions, an elaborate decision-making structure is unnecessary because the partners will tend to reach agreement informally and largely by consensus. Not only is this aspect of partnership governance the one that is most frequently observed,19 it is also the one predicted by Kenneth Arrow's theories of organizational decision making. According to Arrow, where an organization's decision makers have identical information and interests, decisions will be reached by “Consensus” because each participant, voting in his or her own self-interest, will naturally select the course of action preferred by the others.21
Where information and interests differ, however, it is obviously infeasible to involve all participants in the decision-making process. Given the normative goal of increasing the size of the residual interest, it makes sense to confer decisive authority on the residual claimants in a partnership, but only because the partners are also the active managers of the firm. Where the residual claimants are not expected to run the firm and especially when they are many in number (thus increasing disparities in information and interests), their function becomes specialized to risk-bearing, thereby creating both the opportunity and necessity for managerial specialists. Again as Arrow predicts, where information and interests differ, the residuals will no longer either be able or inclined to reach decisions that are in the best interests of their group. Instead, it will become “cheaper and more efficient to transmit all the pieces of information once to a central place” and to have the central place “make the collective decision and transmit it rather than retransmit all the information on which the decision is based.”
Arrow calls this latter decisional structure “Authority” . . ..
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19 It is significant that the default governance rule for partnerships provides for equal participation in management by the partners. See Unif. Partnership Act § 18(e) (1914). Many state corporations statutes permit close corporation shareholders to adopt a partnership-like governance structure by dispensing with the board of directors and assuming direct shareholder control of the business. See, e.g., Del.Code Ann. tit. 8, § 351 (1991). The Revised Model Business Corporation Act has recently been amended to provide even greater flexibility by authorizing the use of unanimous shareholder agreements to tailor the corporation's governance structure to the shareholders' particular needs. See Rev. Model Business Corp. Act § 7.32. This procedure gives close corporation shareholders the same amount of self-determination regarding governance as is available under the Uniform Partnership Act. See generally Committee on Corporate Laws, Changes in the Revised Model Business Corporation Act—Amendments Pertaining to Closely Held Corporations, 46 Bus.Law. 297 (1990).
21 See generally Kenneth J. Arrow, The Limits of Organization (1974).
Michael P. Dooley, Two Models of Corporate Governance, 47 Bus. Law. 461, 466–67 (1992). A Restatement of Public Corporate Law must grapple with the value of authority. In turn, that means you have to grapple with the tradeoff between authority and accountability that drives my work on director primacy:
The director primacy account of corporate governance begins with the observation that 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 intra-corporate contracts by fiat.
Stephen M. Bainbridge, Why the North Dakota Publicly Traded Corporations Act Will Fail, 84 N.D.L. Rev. 1043, 1046 (2008).
Second, if the Restatement does track Delaware law, there is a serious irony here. Dooley was active in leading the opposition to the first effort. Mike was the Reporter for the Model Business Corporation Act and helped lead the ABA Business Law Section’s Ad Hoc Committee on the ALI Corporate Governance Project (known as “CORPRO”). One of CORPO’s main goals was to move the Project TOWARDS Delaware law. See, e.g., Michael P. Dooley & E. Norman Veasey, The Role of the Board in Derivative Litigation: Delaware Law and the Current Ali Proposals Compared, 44 Bus. Law. 503 (1989). For example, “the procedures governing derivative suits gradually moved toward the Delaware position, as did the substantive provisions governing interested-director transactions.” Stephen M. Bainbridge, Independent Directors and the Ali Corporate Governance Project, 61 Geo. Wash. L. Rev. 1034, 1043 (1993).
Third, one of the core problems with the first effort was that it did not restate Delaware law. If you’re going to restate public corporation law, you have to restate Delaware law. But the first effort was managed by Mel Eisenberg—one of the giants of the corporate law academy in the latter part of the 20th Century, for whom I had great admiration—and who bought into the race to the bottom thesis that Delaware law is pure evil. As a result, “Unlike previous restatements prepared by the American Law Institute, the Corporate Governance Project undertook not only to restate the laws governing the internal affairs of corporation, but also to make recommendations on what corporate law should provide and what would be considered good corporate practice.” Elliott Goldstein, Future Articulation of Corporation Law, 39 Bus. Law. 1541 (1984). That approach drove much of the opposition which eventually led the reporters to admit that they were not restating the law, which resulted in the change of name from restatement to Principles. See Dooley, supra, at 493 (noting that the draft document “no longer purports to restate the law”). If you’re going to restate Delaware law, why bother? We have several very fine treatises on Delaware law. In addition, whose word are you going to take on the content of Delaware law: the members of the Delaware judiciary or a bunch of academics and lawyers?
Which brings me to my main concern about the current project. A number of the members of the committee are well known critics of Delaware law and, in some cases, known proponents of federalizing corporate law. Indeed, a number of folks on the committee are among the academics Leo Strine famously accused of pretending that they knew the law of Delaware (re corporate purpose) better than the Delaware judiciary. See Honorable Leo E. Strine, Jr., The Dangers of Denial: The Need for A Clear-Eyed Understanding of the Power and Accountability Structure Established by the Delaware General Corporation Law, 50 Wake Forest L. Rev. 761, 788 (2015) (“Rather than pretend that the law is already what they wish it to be, advocates of change should take on the harder work involved in real reform.”). All honorable folks, but not who I would want to undertake a restatement of Delaware law rather than a running critique thereof.
