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Sunday
Jun032012

Director-Primacy and Team-Production as Real Entity Theories

I have previously debated the appropriateness of viewing director-primacy as a type of real entity theory of the corporation with director-primacy’s most renowned spokesperson, Stephen Bainbridge.  (You can find the last post in the series, with links to the preceding posts, here.) 

I now want to take that discussion a step further by suggesting that team-production theory may also be aligned with real entity theory.

For those of you not familiar with team production theory, you can go here to view the abstract for (and download the text of): Margaret Blair & Lynn Stout, “A Team Production Theory of Corporate Law.”  A relevant portion of the abstract provides that:

[W]e argue that the essential economic function of the public corporation is not to address principal-agent problems, but to provide a vehicle through which shareholders, creditors, executives, rank-and-file employees, and other potential corporate "stakeholders" who may invest firm-specific resources can, for their own benefit, jointly relinquish control over those resources to a board of directors…. The team production model … suggests that maximizing shareholder wealth should not be the principal goal of corporate law. Rather, directors of public corporations should seek to maximize the joint welfare of all the firm's stakeholders …

Thus, it appears clear that director primacy and team production theory differ in terms of what they view as the goal of corporate governance.  For director primacy, it is shareholder wealth maximization.  For team production theory, it is the maximization of “the joint welfare of all the firm's stakeholders.”  However, both theories locate the ultimate decision-making power in the board of directors, and I believe this fact makes them both candidates for alignment with real entity theory as follows.

To begin with, I believe it is important to understand that I come to this issue largely as a result of wanting to coordinate traditional corporate law theories of the corporation with traditional constitutional law theories of the corporation as part of my latest project, “The Silent Role of Corporate Theory in the Supreme Court’s Campaign Finance Cases” (forthcoming in the Penn. Journal of Const. Law—latest draft available for download here).  To that end, it seems relatively non-controversial to align artificial entity theory with concession theory, and nexus-of-contracts theory with the aggregate theory of the corporation.  However, deciding which traditional corporate law theory of the corporation (if any) to match up with real entity theory—the third traditional constitutional theory of the corporation—is a bit more complicated.

At the risk of over-simplification, I think one valid way of approaching the problem is as follows.  First, concession theory and artificial entity theory are aligned because both view the corporation as a creature of the state and tend to presume the state has great discretion in regulating its creation.  Aggregate theory and contractarianism, on the other hand, focus on the “association of citizens” that contract with one another for private gain via the corporate form, and view the state’s role as essentially limited to providing default rules to further private ordering.  While the typical economic analysis of contractarianism can be used to explain the corporate norm of director primacy as a function of efficient private ordering, one assumes it does not require power to be centralized in a board of directors as a normative matter.  The theories of director primacy and team production, however, go much further in establishing the board of directors as the “mediating hierarchy” of choice (though certainly not to the point of mandating such a structure), and therefore could be said to come closer to identifying a specific locus of corporate control that can be said to constitute the “real entity” that represents the corporation.  As Reuven Avi-Yonah has written (here): “The [emergence of the business judgment] rule reflected the real entity view, which equates the corporation with its management, and rejected the aggregate view of the corporation as an aggregate of its shareholders.”

Admittedly, there is some smashing of square pegs into round holes going on here.  Furthermore, given that my project ultimately seeks to distinguish theories of the corporation on the basis of how great a role they assign the state in terms of regulating corporations, distinctions between real entity theory and aggregate theory may be of limited relevance since both currently tend to justify limiting state regulation more than concession theory.  As Atiba Ellis has written (here): "The important implication of this real entity theory is that the corporation has a life completely separate and apart from the state; the state merely records the combination of the private parties and plays only observer of the corporation's formation."  However, I continue to believe there is value to be derived from trying to align the corporate and constitutional theories of the corporation, and to that end view director primacy and team production as good candidates for alignment with real entity theory due to their combination of situating the locus of the corporation in the board of directors and justifying this on the basis of contract rather than regulation.  As Lynn LoPucki has written (here):

The Team Production Theory has striking implications for bankruptcy theory. Applied to bankruptcy reorganization, the Team Production Theory turns existing contractarian bankruptcy theory virtually upside down. Bankruptcy reorganization ceases to be a regulation imposed by government and instead becomes a contract term by which creditors and shareholders agree to subordinate their legal rights to the preservation of the going concern.

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