Bratton, William Wilson, Team Production Revisited (September 29, 2021). U of Penn, Inst for Law & Econ Research Paper No. 21-27, University of Miami Legal Studies Research Paper No. 3935788, Vanderbilt Law Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3935788
This Article reconsiders Margaret Blair and Lynn Stout’s team production model of corporate law, offering a favorable evaluation. The model explains both the legal corporate entity and corporate governance institutions in microeconomic terms as the means to the end of encouraging investment, situating corporations within markets and subject to market constraints but simultaneously insisting that productive success requires that corporations remain independent of markets. The model also integrates the inherited framework of corporate law into an economically derived model of production, constructing a microeconomic description of large enterprises firmly rooted in corporate doctrine but neither focused on nor limited by a description of principal-agent relationships among shareholders and managers. This Article shows that the model retains descriptive robustness, despite the substantial accretion of shareholder power during the two decades since its appearance. The Article also shows that the model taught three groundbreaking lessons to corporate legal theory. First, nothing binds microeconomic analysis together with a theory of the firm rooted in shareholder primacy. Second, microeconomics, with its emphases on efficiency and maximization, can be deployed in the service of an allocatively sensitive description of corporate governance, providing a more capacious methodological tent than anyone in corporate law understood prior to Blair and Stout’s intervention. Third, it is not only possible but arguably necessary to take corporate law seriously when articulating a microeconomic theory of corporate production. To the extent an economic model’s description of the appropriate legal framework differs materially from the inherited legal framework, there is a possible, even a probable, infirmity in the model.
I remain unpersuaded. I have never bought team production as either a descriptive or normative model of corporate governance. To the contrary, I think my director primacy model is superior both descriptively and normatively.
What follows is excerpted from my article Director primacy: The means and ends of corporate governance. 97 Northwestern University Law Review, 547-606 (2003). One of these days I'll get around to updating it for subsequent developments.
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]
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. 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 ....”[2] 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.”[3]
Building on the work of Rajan and Zingales, Blair and Stout define team production by reference to firm specific investments.[4] Hence, for example, they describe the firm “as a ‘nexus of firm-specific investments.’” In fact, however, firm specific investments are not the defining characteristic of team production. Instead, the common feature of team production is task nonseparability.
Oliver Williamson identifies two forms production teams take: primitive and relational. In both, team members perform nonseparable tasks. The two forms are distinguished by the degree of firm specific human capital possessed by such members. In primitive teams, workers have little such capital; in relational teams, they have substantial amounts. Because both primitive and relational team production requires task nonseparability, it is that characteristic that defines team production.
Most public corporations have both relational and primitive teams embedded throughout their organizational hierarchy. Self-directed work teams, for example, have become a common feature of manufacturing shop floors and even some service workplaces. Even the board of directors can be regarded as a relational team. Hence, the modern public corporation arguably is better described as a hierarchy of teams rather than one of autonomous individuals. To call the entire firm a team, however, is neither accurate nor helpful.
As among shop floor workers organized into a self-directed work team, for example, team production is an appropriate model precisely because their collective output is not task separable. In a large firm, however, the vast majority of tasks performed by the firm’s various constituencies are task separable. The contribution of employees of one division versus those of a second division can be separated. The contributions of employees and creditors can be separated. The contributions of supervisory employees can be separated from those of shop floor employees. And so on. Accordingly, the concept of team production is simply inapt with respect to the large public corporations with which Blair and Stout are concerned. [5]
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. If so, the model’s utility is vitiated with respect to close corporations, wholly-owned subsidiaries, and publicly held corporations with a controlling shareholder. In addition, Coates argues, Blair and Stout’s model also fares poorly whenever any corporate constituent dominates the firm. Many of publicly held corporations lacking a controlling shareholder are dominated one of the constituents among which the board supposedly mediates—namely, top management. Although the precise figures disputed, a substantial minority of publicly held corporations have boards in which insiders comprise a majority of the members. Even where a majority of the board is nominally independent, the board may be captured by insiders.
I more skeptical than Coates of board capture theories, having argued elsewhere that independent board members have substantial incentives to buck management. On balance, however, Coates makes a persuasive case that the mediating hierarch model has a relatively small domain. In contrast, the domain of director primacy, which merely requires the absence of a controlling shareholder, seems considerably larger.
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. The participating constituents know that incorporation, especially the selection of independent board members, will reduce their control over the firm and, consequently, expose their interests to shirking or self-dealing by other participants. They go forward, Blair and Stout suggest, because the participants know the board of directors will function as a mediating hierarch resolving horizontal disputes among team members about the allocation of the return on their production.
On its face, Blair and Stout’s scenario is not about established public corporations. Instead, their scenario seems heavily influenced by the high-tech start-ups of the late 1990s. Yet, even in that setting, the model seems inapt. In the typical pattern, the entrepreneurial founders hire the first factors of production.[6] If the firm subsequently goes public,[7] the founding entrepreneurs commonly are replaced by a more or less independent board.[8] 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.[9]
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.[10] The board of directors as an institution thus pre-dates the rise of shareholder capitalism.[11] When the earliest industrial corporations began, moreover, they typically were large enterprises requiring centralized management. Hence, separation of ownership and control was not a late development but rather a key institutional characteristic of the corporate form from its inception.[12] 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.
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.” In other words, the principal function of the mediating board is resolving disputes among other corporate constituents. This account of the board’s role differs significantly from the standard account.
The literature typically identifies three functions performed by boards of public corporations:[13] First, and foremost, the board monitors and disciplines top management. Second, while boards rarely are involved in day-to-day operational decision making, most boards have at least some managerial functions. Broad policymaking is commonly a board prerogative, for example. Even more commonly, however, individual board members provide advice and guidance to top managers with respect to operational and/or policy decisions. Finally, the board provides access to a network of contacts that may be useful in gathering resources and/or obtaining business. Outside directors affiliated with financial institutions, for example, apparently facilitate the firm’s access to capital. In none of these capacities, however, does the board of directors directly referee between corporate constituencies.
To be sure, institutional economics acknowledges that dispute resolution is an important function of any governance system. Ex post gap-filling and error correction are necessitated by the incomplete contracts inherent in corporate governance. Those functions inevitably entail dispute resolution. As we’ve seen, the firm addresses the problem of incomplete contracting by creating a central decisionmaker authorized to rewrite by fiat the implicit—and, in some cases, even the explicit—contracts of which the corporation is a nexus.
As the principal governance mechanism within the public corporation, the board of directors is that central decisionmaker and, accordingly, bears principal dispute resolution responsibility. Yet, in doing so, the board “is an instrument of the residual claimants.” Hence, if the board considers the interests of nonshareholder constituencies when making decisions, it does so only because shareholder wealth will be maximized in the long run.
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. 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.
If directors suddenly began behaving as mediating hierarchs, rather than shareholder wealth maximizers, an adaptive response would be called forth.[14] 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.
[1] 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] 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).
[3] Kenneth L. Bettenhausen, Five Years of Groups Research: What have we Learned and What Needs to be Addressed?, 17 J. Mgmt. 345, 346 (1991)
[4] Of course, many corporate constituents invest little in firm specific capital (human or otherwise), but this is mere quibbling. 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).
[5] 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.
[6] 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).
[7] Blair and Stout suggest that the decision of such promoters to subsequently go public “may be driven in part by team production considerations.” 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).
[8] 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”).
[9] 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).
[10] 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).
[11] 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).
[12] 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).
[13] 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).
[14] 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 decision-making power, however, we require a more robust theory of director motive.
