Stephen Bainbridge was kind enough to respond to my post from last week, wherein I noted that in my most recent paper I had aligned his director-primacy theory with real entity theory rather than aggregate theory. (You can find my paper here, my post from last week here, and Bainbridge’s reply here.) As expected, he disagreed with my approach and I’d like to summarize his response and make some additional comments.
Basically, Bainbridge reaffirms that he grounds director-primacy squarely within aggregate / contractarian theory. To the extent that there is some rhetoric attributable to him that suggests an openness to entity theory, it is better understood as distinguishing the theory of connected contracts. Thus, the following passage from Bainbridge’s “The Board of Directors as Nexus of Contracts” is best understood as acknowledging that there is indeed something more to the corporation than individuals contracting directly with one another, and that this something more is properly understood to be the board of directors serving as a nexus for contracting—but this is not the same thing as saying that the corporation itself is some independent real or artificial entity.
To be sure, the traditional insistence that the firm is a real entity tends towards mindless formalism. Yet, perhaps some deference should be shown the corporation’s status as a legal person. Corporate constituents contract not with each other, but with the corporation. A bond indenture thus is a contract between the corporation and its creditors, an employment agreement is a contract between the corporation and its workers, and a collective bargaining agreement is a contract between the corporation and the union representing its workers. If the contract is breached on the corporate side, it will be the entity that is sued in most cases, rather than the individuals who decided not to perform. If the entity loses, damages typically will be paid out of its assets and earnings rather than out of those individuals’ pockets. To dismiss all of this as mere reification ignores the axiom that ideas have consequences.
Next, Bainbridge points out that while certain aspects of real entity theory overlap with aspects of director-primacy theory (they both, as Avi-Yonah puts it in describing real entity theory (here), shield management “from undue interference from both shareholders and the state”), this is not enough to tear director-primacy away from contractarianism. As Bainbridge notes: “Just because two roads end up in the same place, doesn't mean that they are one and the same.” Rather, director-primacy is best situated within contractarianism because its primary attributes of power-of-fiat and the protections of the business judgment rule exist because they “are majoritarian defaults provided by the law to facilitate private ordering. Not because the corporation is an entity.”
Finally, Bainbridge equates any theory that requires him to “think of the corporation as an entity--real or otherwise--rather than as an aggregate” with “metaphysical mumbo jumbo” and “transcendental nonsense.” Writes Bainbridge: “I just can't wrap my head around the metaphysical abstractions.”
By way of response, let me start at the end by saying that I may have just as much trouble with any theory that requires me to think of corporations as nothing more than an association of individuals. Bring together any group of random individuals you like and they can desire with all their might to incorporate, but without the assistance of the state they will be left a general partnership. One might respond to this by saying that what the state asks of them in order to incorporate is not much, but as Grant Hayden and Matthew Bodie have put it (here): “One cannot contract to form a corporation…. The fact that th[e] permission [to incorporate] is readily granted … does not change the fact that permission is required.” I might go so far as to say that any theory that requires me to ignore all the things that make some international conglomerates more powerful than small nations on the basis of the mantra that they are mere “associations of citizens” is likewise asking me to engage in metaphysical mumbo jumbo and transcendental nonsense.
If one understands “aggregate” theory, “real entity” theory, and “artificial entity” theory to effectively be terms of art that, among other things, try to describe a rational theoretical basis for deciding how much deference to give the state in terms of regulating corporations (and for what ends), then the fact that there is no physical entity associated with the corporation should not preclude finding real or artificial entity theory to be useful. Furthermore, if one takes seriously the distinction between nexus-of-contracts theory in general and director-primacy theory in particular, and if one further takes seriously the need to align corporate and constitutional theories of the corporation, then making room for both contractarianism and director-primacy, along with aggregate and real entity theory, seems at least defensible in light of the overlap between the theories mentioned above. As J.W. Verret has put it in differentiating contractarianism from director-primacy (here):
The contractarian model is in many ways a precursor to two subsequent corporate theories, the shareholder primacy model and the director primacy model. Both of those offshoots of the contractarian approach accept shareholder wealth maximization as the determining factor in designing default rules to govern the corporate enterprise, but they differ as to the appropriate allocation of power between shareholders and corporate directors.
Having said all that, I certainly don’t want to get overly distracted from my primary goal in writing the paper, which is to encourage the Supreme Court to discuss corporate theory expressly (and I believe this is an area where Bainbridge and I are in agreement). As I have said previously, arguments about where to locate director-primacy vis-à-vis constitutional theories of the corporation may ultimately have little impact on that agenda. At the same time, I certainly don’t want to advocate an indefensible position. While I am willing to concede this debate if necessary, to this point I’m still comfortable that at the very least I have a colorable claim to make regarding director-primacy as real entity theory. As for my own lingering questions about whether the business judgment rule and board power-of-fiat are best understood as “majoritarian defaults provided by the law to facilitate private ordering”—I’m leaving that for my next project, tentatively entitled “Rehabilitating Concession Theory” (go here for the ironic title inspiration).