Yale law school Program for Studies in Law Ec d Public polie Law and Economics Working Paper No 235 New York University Center for Law and Business Law and economics Working Paper No 013 Harvard law school John M. olin Center for Law Economics. and business Discussion Paper no 280 Yale International Center for Finance Working Paper No. 00-09 The end of History for Corporate law January 2000 Henry hansmann and reinier Kraakman This paper can be downloaded without charge from The Harvard John M. Olin Discussion Paper Series http://www.lawharvardedu/programs/olincenter The Social Science Research Network Electronic Paper Collection http://papers.ssrn.com/paper.taf?abstractid=204528
Yale Law School Program for Studies in Law, Economics, and Public Policy Law and Economics Working Paper No. 235 New York University Center for Law and Business Law and Economics Working Paper No. 013 Harvard Law School John M. Olin Center for Law, Economics, and Business Discussion Paper No. 280 Yale International Center for Finance Working Paper No. 00-09 The End of History for Corporate Law January 2000 Henry Hansmann and Reinier Kraakman This paper can be downloaded without charge from: The Harvard John M. Olin Discussion Paper Series: http://www.law.harvard.edu/programs/olin_center/ The Social Science Research Network Electronic Paper Collection: http://papers.ssrn.com/paper.taf?abstract_id=204528
THE END OF HISTORY FOR CORPORATE LAW Henry Hansmann Yale law school Visiting, NYU School of Law Reinier Kraakman Harvard law school January 2000 Comments welcome. Send correspondence to Henry Hansmann Reinier Kraakman NYU School of law room 335 Harvard Law school 40 Washington Square South Cambridge, MA 02138 New York. NY 10012 617496-3586 212-998-6132 617-496-6118fax 212-995-4763fax kraakman @law. harvard. edu henry hansmann @yale. edu Earlier drafts of this essay were presented at conferences entitled"Are corporate Governance Systems Converging? held at Columbia Law School, December 5 1997, and"Convergence and Diversity in Corporate Governance Regimes and Capital Markets, sponsored by Tilburg University in Eindhoven, The Netherlands on November 4-5, 1999. We both wish to thank the New York University School of Law and its Dean, John Sexton, for generous support in this project while both authors were visiting professors
THE END OF HISTORY FOR CORPORATE LAW Henry Hansmann Yale Law School Visiting, NYU School of Law Reinier Kraakman Harvard Law School January 2000 Comments welcome. Send correspondence to: Henry Hansmann NYU School of Law, Room 335 40 Washington Square South New York, NY 10012 212-998-6132 212-995-4763 fax henry.hansmann@yale.edu Reinier Kraakman Harvard Law School Cambridge, MA 02138 617-496-3586 617-496-6118 fax kraakman@law.harvard.edu Earlier drafts of this essay were presented at conferences entitled “Are Corporate Governance Systems Converging?” held at Columbia Law School, December 5, 1997, and “Convergence and Diversity in Corporate Governance Regimes and Capital Markets,” sponsored by Tilburg University in Eindhoven, The Netherlands, on November 4 - 5, 1999. We both wish to thank the New York University School of Law and its Dean, John Sexton, for generous support in this project while both authors were visiting professors
The End of History for Corporate Law Henry Hansmann Yale Law school Reinier Kraakman Harvard law school ABSTRACT Despite the apparent divergence in institutions of govenance, share ownership, capital markets, and business culture across developed economies, the basic law of the corporate form has already achieved a high degree of uniformity and continued convergence is likely. A principal reason for convergence is a widespread normative consensus that corporate managers should act exclusively in the economic interests of shareholders, including noncontrolling shareholders. This consensus on a shareholder- oriented model of the corporation results in part from the failure of alternative models of the corporation, including the manager-oriented model that evolved in the U.s. in the 1950s and 60s, the labor-oriented model that reached its apogee in German co-determination, and the state-oriented model that until recently was dominant in france and much of asi Other reasons for the new consensus include the competitive success of contemporary British and American firms, the growing influence worldwide of the academic disciplines of economics and finance, the diffusion of share ownership in developed countries, and the emergence of active shareholder representatives and interest groups in major jurisdictions. Since the dominant corporate ideology of shareholder primacy is unlikely to be undone, its success represents the "end of history for corporate law The ideology of shareholder primacy is likely to press all major jurisdictions toward similar rules of corporate law and practice. Although some differences may persist as a result of institutional or historical contingencies, the bulk of legal development worldwide will be toward a standard legal model of the corporation. For the most part, this development will enhance the efficiency of corporate laws and practices. In some cases however, jurisdictions may converge on inefficient rules, as when the universal rule of limited shareholder liability permits shareholders to externalize the costs of corporate torts JEL Classifications: F20. G34 K22
The End of History for Corporate Law by Henry Hansmann Yale Law School Reinier Kraakman Harvard Law School ABSTRACT Despite the apparent divergence in institutions of governance, share ownership, capital markets, and business culture across developed economies, the basic law of the corporate form has already achieved a high degree of uniformity, and continued convergence is likely. A principal reason for convergence is a widespread normative consensus that corporate managers should act exclusively in the economic interests of shareholders, including noncontrolling shareholders. This consensus on a shareholderoriented model of the corporation results in part from the failure of alternative models of the corporation, including the manager-oriented model that evolved in the U.S. in the 1950's and 60's, the labor-oriented model that reached its apogee in German co-determination, and the state-oriented model that until recently was dominant in France and much of Asia. Other reasons for the new consensus include the competitive success of contemporary British and American firms, the growing influence worldwide of the academic disciplines of economics and finance, the diffusion of share ownership in developed countries, and the emergence of active shareholder representatives and interest groups in major jurisdictions. Since the dominant corporate ideology of shareholder primacy is unlikely to be undone, its success represents the “end of history” for corporate law. The ideology of shareholder primacy is likely to press all major jurisdictions toward similar rules of corporate law and practice. Although some differences may persist as a result of institutional or historical contingencies, the bulk of legal development worldwide will be toward a standard legal model of the corporation. For the most part, this development will enhance the efficiency of corporate laws and practices. In some cases, however, jurisdictions may converge on inefficient rules, as when the universal rule of limited shareholder liability permits shareholders to externalize the costs of corporate torts. JEL Classifications: F20, G34, K22
l. INTRODUCTION Recent scholarship has emphasized institutional differences in governance, share ownership, capital markets, and business culture among European, American, and Japanese companies. Despite this apparent divergence, however, the basic law of corporate governance -indeed, most of corporate law-has achieved a high degree of uniformity across these jurisdictions, and continuing convergence toward a single standard model is likely. The core legal features of the corporate form were already well established in advanced jurisdictions 100 years ago, at the turn of the twentieth centur Although there remained considerable room for variation in governance practices and in the fine structure of corporate law throughout the twentieth century, the pressures for further convergence are now rapidly growing. Chief among these pressures is the recent dominance of a shareholder-centered ideology of corporate law among the business government, and legal elites in key commercial jurisdictions. There is no longer any serious competitor to the view that corporate law should principally strive to increase long term shareholder value. This emergent consensus has already profoundly affected corporate governance practices throughout the world. It is only a matter of time before its influence is felt in the reform of corporate law as we I. CONVERGENCE PAST: THE RISE OF THE CORPORATE FORM We must begin with the recognition that the law of business corporations had nineteenth century By that time, large-scale business enterprise in every ma/or o already achieved a remarkable degree of worldwide convergence at the end of the commercial jurisdiction had come to be organized in the corporate form, and the core functional features of that form were essentially identical across these jurisdictions. Those features, which continue to characterize the corporate form today, are: (1)full legal personality, including well-defined authority to bind the firm to contracts and to bond those contracts with assets that are the property of the firm as distinct from the firms owners, (2) limited liability for owners and managers, 3) shared ownership by investors of capital, (4) delegated management under a board structure, and ( 5) transferable shares 1. See, e.g., Mark Roe, Some Differences in Company Structure in Germany, Japan, and the United States, 102 YALE L.J. 1927(1993) Ronald J. Gilson Mark J Roe, Understanding the Japanese Keiretsu: Overlaps Between Company Governance and Industrial Organization, 102 YALE L.J. 871(1993): Bernard s Black& John C Coffee, Hail Britannia? Institutional Investor Behavior Under Limited Regulation, 92 McH.L.REVv.197(1994) 2. See Henry Hansmann and Reinier Kraakman, The Essential Role of Organizational Law (Yale Law School and Harvard Law school, 1999)
1. See, e.g., Mark Roe, Some Differences in Company Structure in Germany, Japan, and the United States, 102 YALE L. J. 1927 (1993); Ronald J. Gilson & Mark J. Roe, Understanding the Japanese Keiretsu: Overlaps Between Company Governance and Industrial Organization, 102 YALE L. J. 871 (1993); Bernard S. Black & John C. Coffee, Hail Britannia? Institutional Investor Behavior Under Limited Regulation, 92 MICH. L. REV. 1997 (1994). 2. See Henry Hansmann and Reinier Kraakman, The Essential Role of Organizational Law (Yale Law School and Harvard Law School, 1999). 1 I. INTRODUCTION Recent scholarship has emphasized institutional differences in governance, share ownership, capital markets, and business culture among European, American, and Japanese companies.1 Despite this apparent divergence, however, the basic law of corporate governance -- indeed, most of corporate law -- has achieved a high degree of uniformity across these jurisdictions, and continuing convergence toward a single standard model is likely. The core legal features of the corporate form were already well established in advanced jurisdictions 100 years ago, at the turn of the twentieth century. Although there remained considerable room for variation in governance practices and in the fine structure of corporate law throughout the twentieth century, the pressures for further convergence are now rapidly growing. Chief among these pressures is the recent dominance of a shareholder-centered ideology of corporate law among the business, government, and legal elites in key commercial jurisdictions. There is no longer any serious competitor to the view that corporate law should principally strive to increase longterm shareholder value. This emergent consensus has already profoundly affected corporate governance practices throughout the world. It is only a matter of time before its influence is felt in the reform of corporate law as well. II. CONVERGENCE PAST: THE RISE OF THE CORPORATE FORM We must begin with the recognition that the law of business corporations had already achieved a remarkable degree of worldwide convergence at the end of the nineteenth century. By that time, large-scale business enterprise in every major commercial jurisdiction had come to be organized in the corporate form, and the core functional features of that form were essentially identical across these jurisdictions. Those features, which continue to characterize the corporate form today, are: (1) full legal personality, including well-defined authority to bind the firm to contracts and to bond those contracts with assets that are the property of the firm as distinct from the firm’s owners,2 (2) limited liability for owners and managers, (3) shared ownership by investors of capital, (4) delegated management under a board structure, and (5) transferable shares
These core characteristics, both individually and in combination, offer important efficiencies in organizing the large firms with multiple owners that have come to dominate developed market economies. We explore those efficiencies in detail elsewhere. What is important to note here is that, while those characteristics and their associated efficiencies are now commonly taken for granted, prior to the beginning of the nineteenth century there existed only a handful of specially chartered companies that combined all five of these characteristics. The joint stock company with tradeable shares was not made generally available for business activities in England until 1844, and limited liability was not added to the form until 1855. While some American states developed the form for general use a few years earlier, all general business corporation statues appear to date from well after 1800. By around 1900, however, every major commercial jurisdiction appears to have provided for at least one standard-form legal entity with the five characteristics listed above as the default rules and this has remained the case ever sInce Thus there was already strong and rapid convergence a century ago regarding the basic elements of the law of business corporations. It is, in general, only in the more detailed structure of corporate law that jurisdictions have varied significantly since then The five basic characteristics of the corporate form provide, by their nature, for a firm that is strongly responsive to shareholder interests. They do not, however, necessarily dictate how the interests of other participants in the firm -such as employees, creditors other suppliers, customers, or society at large - will be accommodated. Nor do they dictate the way in which conflicts of interest among shareholders themselves-and particularly between controlling and noncontrolling shareholders-will be resolved Throughout most of the twentieth century there has been debate over these issues, and experimentation with alternative approaches to them Recent years, however, have brought strong evidence of a growing consensus on these issues among the academic, business, and governmental elites in leading jurisdictions. The principal elements of this consensus are that ultimate control over the corporation should be in the hands of the shareholder class; that the managers of the corporation should be charged with the obligation to manage the corporation in the interests of its shareholders; that other corporate constituencies, such as creditors 3. Henry Hansmann and Reinier Kraakman, What is Corporate Law?, Chapter 1 in Reinier Kraakman, Gerard Hertig, Henry Hansmann, hideki Kanda, eds, THE ANATOMY OF CORPORATE LAW: A COMPARATIVE AND FUNCTIONAL APPROACH(working draft, June 999); Henry Hansmann, The OWNERSHIP OF ENTERPRISE(1996) 4. Phillip Blumberg, THE LAW OF CORPORATE GROUPS: SUBSTANTIVE LAW, 9-20 (1988)
3. Henry Hansmann and Reinier Kraakman, What is Corporate Law? , Chapter 1 in Reinier Kraakman, Gerard Hertig, Henry Hansmann, & Hideki Kanda, eds, THE ANATOMY OF CORPORATE LAW: A COMPARATIVE AND FUNCTIONAL APPROACH (working draft, June 1999); Henry Hansmann, The OWNERSHIP OF ENTERPRISE (1996). 4. Phillip Blumberg, THE LAW OF CORPORATE GROUPS: SUBSTANTIVE LAW, 9-20 (1988). 2 These core characteristics, both individually and in combination, offer important efficiencies in organizing the large firms with multiple owners that have come to dominate developed market economies. We explore those efficiencies in detail elsewhere.3 What is important to note here is that, while those characteristics and their associated efficiencies are now commonly taken for granted, prior to the beginning of the nineteenth century there existed only a handful of specially chartered companies that combined all five of these characteristics. The joint stock company with tradeable shares was not made generally available for business activities in England until 1844, and limited liability was not added to the form until 1855.4 While some American states developed the form for general use a few years earlier, all general business corporation statues appear to date from well after 1800. By around 1900, however, every major commercial jurisdiction appears to have provided for at least one standard-form legal entity with the five characteristics listed above as the default rules, and this has remained the case ever since. Thus there was already strong and rapid convergence a century ago regarding the basic elements of the law of business corporations. It is, in general, only in the more detailed structure of corporate law that jurisdictions have varied significantly since then. The five basic characteristics of the corporate form provide, by their nature, for a firm that is strongly responsive to shareholder interests. They do not, however, necessarily dictate how the interests of other participants in the firm -- such as employees, creditors, other suppliers, customers, or society at large -- will be accommodated. Nor do they dictate the way in which conflicts of interest among shareholders themselves – and particularly between controlling and noncontrolling shareholders – will be resolved. Throughout most of the twentieth century there has been debate over these issues, and experimentation with alternative approaches to them. Recent years, however, have brought strong evidence of a growing consensus on these issues among the academic, business, and governmental elites in leading jurisdictions. The principal elements of this consensus are that ultimate control over the corporation should be in the hands of the shareholder class; that the managers of the corporation should be charged with the obligation to manage the corporation in the interests of its shareholders; that other corporate constituencies, such as creditors
employees, suppliers, and customers should have their interests protected by contractual and regulatory means rather than through participation in corporate governance; that noncontrolling shareholders should receive strong protection from exploitation at the hands of controlling shareholders; and that the principal measure of the interests of the publicly traded corporations shareholders is the market value of their shares in the firm. For shall refer to the view of the corporation that comprises these elements the" standard shareholder-oriented model of the corporate form (or, for brevity, simply"the standard model). To the extent that corporate law bears on the implementation of this standard model -as to an important degree it does-this consensus on the appropriate conduct of corporate affairs is also a consensus as to the appropriate content of corporate law, and is likely to have profound effects on the structure of that law Thus, just as there was rapid crystallization of the core features of the corporate form in the late nineteenth century, at the beginning of the twenty-first century we are witnessing rapid convergence on the standard shareholder-oriented model as a normative view of corporate structure and governance, and we should expect this normative convergence to produce substantial convergence as well in the practices of corporate governance and in corporate law There are three principal factors driving consensus on the standard model: the failure of alternative models the competitive pressures of global commerce; and the shift of interest group influence in favor of an emerging shareholder class. We consider these developments here in sequence II. THE FAILURE OF ALTERNATIVE MODELS Debate and experimentation concerning the basic structure of corporate law during the twentieth century centered on the ways in which that law should accommodate the interests of non-shareholder constituencies. In this regard, three principal alternatives to a shareholder-oriented model were the traditional foci of attention We term these the manager-oriented, the labor-oriented, and the state-oriented models of corporate law Although each of these three alternative models has-at various points and in various jurisdictions -achieved some success both in practice and in received opinion, all three have ultimately lost much of their normative appeal Recent academic literature has focused on the stakeholder model of the corporation as the principal alternative to the shareholder-oriented model. The stakeholder model, however, is essentially just a combination of elements found in the older manager-oriented and labor-oriented models. Consequently, the same forces that have been discrediting the latter models are also undermining the stakeholder model as a viable alternative to the shareholder-oriented model
3 employees, suppliers, and customers should have their interests protected by contractual and regulatory means rather than through participation in corporate governance; that noncontrolling shareholders should receive strong protection from exploitation at the hands of controlling shareholders; and that the principal measure of the interests of the publicly traded corporation’s shareholders is the market value of their shares in the firm. For simplicity, we shall refer to the view of the corporation that comprises these elements as the “standard shareholder-oriented model” of the corporate form (or, for brevity, simply “the standard model”). To the extent that corporate law bears on the implementation of this standard model – as to an important degree it does – this consensus on the appropriate conduct of corporate affairs is also a consensus as to the appropriate content of corporate law, and is likely to have profound effects on the structure of that law. Thus, just as there was rapid crystallization of the core features of the corporate form in the late nineteenth century, at the beginning of the twenty-first century we are witnessing rapid convergence on the standard shareholder-oriented model as a normative view of corporate structure and governance, and we should expect this normative convergence to produce substantial convergence as well in the practices of corporate governance and in corporate law. There are three principal factors driving consensus on the standard model: the failure of alternative models; the competitive pressures of global commerce; and the shift of interest group influence in favor of an emerging shareholder class. We consider these developments here in sequence. III. THE FAILURE OF ALTERNATIVE MODELS Debate and experimentation concerning the basic structure of corporate law during the twentieth century centered on the ways in which that law should accommodate the interests of non-shareholder constituencies. In this regard, three principal alternatives to a shareholder-oriented model were the traditional foci of attention. We term these the manager-oriented, the labor-oriented, and the state-oriented models of corporate law. Although each of these three alternative models has -- at various points and in various jurisdictions -- achieved some success both in practice and in received opinion, all three have ultimately lost much of their normative appeal. Recent academic literature has focused on the “stakeholder” model of the corporation as the principal alternative to the shareholder-oriented model. The stakeholder model, however, is essentially just a combination of elements found in the older manager-oriented and labor-oriented models. Consequently, the same forces that have been discrediting the latter models are also undermining the stakeholder model as a viable alternative to the shareholder-oriented model
A. The Manager-Oriented Model In the U.S., there existed an important strain of normative thought from the 1930s through the 1960s that extolled the virtues of granting substantial discretion to the managers of large business corporations. Merrick Dodd and John Kenneth Galbraith, for example, were conspicuously identified with this position, and Adolph Berle came to it late in life. At the core of this view was the belief that professional corporate managers could serve as disinterested technocratic fiduciaries who would guide business corporations to perform in ways that would serve the general public interest. The corporate social responsibility literature of the 1950s can be seen as an embodiment of these views.6 The normative appeal of this view arguably provided part of the rationale for the various legal developments in U.S. law in the 1950s and 1960s that tended to reinforce the discretionary authority of corporate managers, such as the sec proxy rules and the Williams Act. The collapse of the conglomerate movement in the 1970s and 1980s however, largely destroyed the normative appeal of the managerialist model. It is now the conventional wisdom that, when managers are given great discretion over corporate investment policies, they mostly end up serving themselves, however well-intentioned they may be. While managerial firms may be in some ways more efficiently responsive to nonshareholder interests than are firms that are more dedicated to serving their shareholders, the price paid in inefficiency of operations and excessive investment in low- value projects is now considered too dear 5. Dodd and Berle conducted a classic debate on the subject in the 1930s, in which Dodd pressed the social responsibility of corporate managers while Berle championed shareholder interests. Adolph A Berle, Corporate Powers as Powers in Trust, 44 HARVARD LAW REVIEW 1049(1931);E. Merrick Dodd, For Whom are Corporate Managers Trustees? 45 HARVARD LAW REVIEW 1145 (1932): Adolph Berle, For Whom Corporate Managers Are Trustees: A Note, 45 HARVARD LAW REVIEW 1365(1932 ). B the 1950,s, Berle seemed to have come around to Dodd's celebration of managerial discretion as a positive virtue that permits managers to act in the interests of society as a whole. See Adolph A Berle, POWER WITHOUT PROPERTY: A NEW DEVELOPMENT IN AMERICAN POLITICAL ECONOMY 107-110(1959). John Kenneth Galbraith takes a similar position in THE NEW INDUSTRIAL STATE (1967) 6. See, e.g., Galbraith, supra, and Berle(1959), supra. For an important collection of essays arguing both sides of the question of managerial responsibility to the broader interests of society see Edward Mason ed, THE CORPORATION IN MODERN SOCIETY (1959)
5. Dodd and Berle conducted a classic debate on the subject in the 1930's, in which Dodd pressed the social responsibility of corporate managers while Berle championed shareholder interests. Adolph A. Berle, Corporate Powers as Powers in Trust, 44 HARVARD LAW REVIEW 1049 (1931); E. Merrick Dodd, For Whom are Corporate Managers Trustees? 45 HARVARD LAW REVIEW 1145 (1932); Adolph Berle, For Whom Corporate Managers Are Trustees: A Note, 45 HARVARD LAW REVIEW 1365 (1932). By the 1950's, Berle seemed to have come around to Dodd’s celebration of managerial discretion as a positive virtue that permits managers to act in the interests of society as a whole. See Adolph A. Berle, POWER WITHOUT PROPERTY: A NEW DEVELOPMENT IN AMERICAN POLITICAL ECONOMY 107-110 (1959). John Kenneth Galbraith takes a similar position in THE NEW INDUSTRIAL STATE (1967). 6. See, e.g., Galbraith, supra, and Berle (1959), supra. For an important collection of essays arguing both sides of the question of managerial responsibility to the broader interests of society, see Edward Mason, ed., THE CORPORATION IN MODERN SOCIETY (1959). 4 A. The Manager-Oriented Model In the U.S., there existed an important strain of normative thought from the 1930s through the 1960s that extolled the virtues of granting substantial discretion to the managers of large business corporations. Merrick Dodd and John Kenneth Galbraith, for example, were conspicuously identified with this position, and Adolph Berle came to it late in life.5 At the core of this view was the belief that professional corporate managers could serve as disinterested technocratic fiduciaries who would guide business corporations to perform in ways that would serve the general public interest. The corporate social responsibility literature of the 1950s can be seen as an embodiment of these views.6 The normative appeal of this view arguably provided part of the rationale for the various legal developments in U.S. law in the 1950s and 1960s that tended to reinforce the discretionary authority of corporate managers, such as the SEC proxy rules and the Williams Act. The collapse of the conglomerate movement in the 1970s and 1980s, however, largely destroyed the normative appeal of the managerialist model. It is now the conventional wisdom that, when managers are given great discretion over corporate investment policies, they mostly end up serving themselves, however well-intentioned they may be. While managerial firms may be in some ways more efficiently responsive to nonshareholder interests than are firms that are more dedicated to serving their shareholders, the price paid in inefficiency of operations and excessive investment in lowvalue projects is now considered too dear
B. The labor -oriented model Large-scale enterprise clearly presents problems of labor contracting. Simple contracts, and the basic doctrines of contract law, are inadequate in themselves to goven the long-term relationships between workers and the firms that employ them elationships that may be affiicted by, among other things, substantial transaction-specific investments and asymmetries of information Collective bargaining via organized unions has been one approach to those problems-an approach that lies outside corporate law, since it is not dependent on the organizational structure of the firms with which the employees bargain. Another approach has been to involve employees directly in corporate govenance by, for example, providing for employee representation on the firms board of directors. Although serious attention was given to employee participation in corporate governance in Germany as early as the Weimar Republic, unionism was the dominant approach everywhere until the Second World War. Then, after the War, serious experimentation with employee participation in corporate governance began in Europe. The results of this experimentation are most conspicuous in Germany where, under legislation initially adopted for the coal and steel industry in 1951 and extended by stages to the rest of German industry between 1952 and 1976, employees are entitled to elect half of the members of the(upper-tier) board of directors in all large German firms. While this German form of"codetermination has been the most far-reaching experiment, a number of other European countries have also experimented with employee participation in more modest ways, giving employees some form of mandatory minority representation on the boards of large corporations Enthusiasm for employee participation crested in the 1970s with the radical expansion of codetermination in Germany and the drafting of the European Community 's proposed Fifth Directive on Company Law, under which German-style codetermination would be extended throughout Europe. Employee participation also attracted considerable attention in the U.S. during that period as adversarial unionism began lose its appeal as a means of dealing with problems of labor contracting and, in fact, began to disappear from the industrial scene Since then, worker participation in corporate governance has steadily lost powe a normative ideal. Despite repeated watering-down, Europe's Fifth Directive has never become law, and it now seems highly unlikely that German-style codetermination will ever be adopted elsewhere. The growing view today is that meaningful direct worker voting participation in corporate affairs tends to produce inefficient decisions, paralysis, or weak boards, and that these costs are likely to exceed any potential benefits that worker participation might bring. The problem, at root, seems to be one of governance. While 7. Proposal for a Fifth Company Law Directive, 1983 0.J(C240)2 5
7. Proposal for a Fifth Company Law Directive, 1983 O.J. (C240)2. 5 B. The Labor-Oriented Model Large-scale enterprise clearly presents problems of labor contracting. Simple contracts, and the basic doctrines of contract law, are inadequate in themselves to govern the long-term relationships between workers and the firms that employ them – relationships that may be afflicted by, among other things, substantial transaction-specific investments and asymmetries of information. Collective bargaining via organized unions has been one approach to those problems -- an approach that lies outside corporate law, since it is not dependent on the organizational structure of the firms with which the employees bargain. Another approach has been to involve employees directly in corporate governance by, for example, providing for employee representation on the firm’s board of directors. Although serious attention was given to employee participation in corporate governance in Germany as early as the Weimar Republic, unionism was the dominant approach everywhere until the Second World War. Then, after the War, serious experimentation with employee participation in corporate governance began in Europe. The results of this experimentation are most conspicuous in Germany where, under legislation initially adopted for the coal and steel industry in 1951 and extended by stages to the rest of German industry between 1952 and 1976, employees are entitled to elect half of the members of the (upper-tier) board of directors in all large German firms. While this German form of “codetermination” has been the most far-reaching experiment, a number of other European countries have also experimented with employee participation in more modest ways, giving employees some form of mandatory minority representation on the boards of large corporations. Enthusiasm for employee participation crested in the 1970s with the radical expansion of codetermination in Germany and the drafting of the European Community’s proposed Fifth Directive on Company Law,7 under which German-style codetermination would be extended throughout Europe. Employee participation also attracted considerable attention in the U.S. during that period, as adversarial unionism began to lose its appeal as a means of dealing with problems of labor contracting and, in fact, began to disappear from the industrial scene. Since then, worker participation in corporate governance has steadily lost power as a normative ideal. Despite repeated watering-down, Europe’s Fifth Directive has never become law, and it now seems highly unlikely that German-style codetermination will ever be adopted elsewhere. The growing view today is that meaningful direct worker voting participation in corporate affairs tends to produce inefficient decisions, paralysis, or weak boards, and that these costs are likely to exceed any potential benefits that worker participation might bring. The problem, at root, seems to be one of governance. While
direct employee participation in corporate decision-making may mitigate some of the inefficiencies that can beset labor contracting the workforce in typical firms is too heterogeneous in its interests to make an effective governing body-and the problems are magnified greatly when employees must share governance with investors, as in codetermined firms. In general, contractual devices, whatever their weaknesses, are and other collective choice mechanisms in resolving conflicts of interest among an tino then supplemented by appropriate labor market regulation evidently superior to voting between a corporation s investors and employees. 8 Today, even inside germany, few commentators argue for codetermination as a general model for corporate law in other jurisdictions. Rather, codetermination now tends to be defended in germany as, at most, a workable adaptation to local interests and circumstances or, even more modestly, as an experiment of questionable value that would now be politically difficult to undo. g C. The State-Oriented Model Both before and after the Second World War, there was widespread support for a corporatist system in which the government would play a strong direct role in the affairs of large business firms to provide some assurance that private enterprise would serve the public interest. Technocratic governmental bureaucrats, the theory went, would help to avoid the deficiencies of the market through the direct exercise of influence in corporate affairs. This approach was most extensively realized in post-war France and Japan. In the United States, though there was little actual experimentation with this approach outside of Andrew Shonfield's 1967 book Modern Capitalism, with its admiring description or was o the defense industries, the model attracted considerable intellectual attention. Perhaps the most infiuential exposition of the state-oriented model in the Anglo-American world wa 8 Henry Hansmann, supra note 2, at 89-119; Henry Hansmann, Worker Participation and Corporate Governance, 43 UNIVERSITY OF TORONTO LAW JOURNAL 589-606 (1993) Henry Hansmann, Probleme von Kollektiventscheidungen und Theorie der Firma Folgerungen fur die Arbeitnehmermitbestimmung, in Claus Ott and Hans-Bernd Schafer editors, OKONOMISCHE ANALYSE DES UNTERNEHMENSRECHTS 287-305(1993). On the weaknesses of German boards, see, e.g., Mark Roe, German Securities Markets and German Codetermination, 98 COLUMBIA BUSINESS LAW REVIEW 167(1998) 9. Some commentators, of course, continue to see co-determination as a core element of a unique Northern European form of corporate governance. See, e.g., Michel Albert, CAPITALISM VS CAPITALISM(1993(asserting the superiority of the" Rhine Model of captialism over the "Anglo-Saxon Model). Even Albert concedes, however, the growing ideological power of shareholder-oriented corporate governance. Id at 169-190 6
8. Henry Hansmann, supra note 2, at 89-119; Henry Hansmann, Worker Participation and Corporate Governance, 43 UNIVERSITY OF TORONTO LAW JOURNAL 589-606 (1993); Henry Hansmann, Probleme von Kollektiventscheidungen und Theorie der Firma -- Folgerungen für die Arbeitnehmermitbestimmung, in Claus Ott and Hans-Bernd Schäfer, editors, ÖKONOMISCHE ANALYSE DES UNTERNEHMENSRECHTS 287-305 (1993). On the weaknesses of German boards, see, e.g., Mark Roe, German Securities Markets and German Codetermination, 98 COLUMBIA BUSINESS LAW REVIEW 167 (1998). 9. Some commentators, of course, continue to see co-determination as a core element of a unique Northern European form of corporate governance. See, e.g., Michel Albert, CAPITALISM VS. CAPITALISM (1993) (asserting the superiority of the “Rhine Model” of captialism over the “Anglo-Saxon Model”). Even Albert concedes, however, the growing ideological power of shareholder-oriented corporate governance. Id. at 169 -190. 6 direct employee participation in corporate decision-making may mitigate some of the inefficiencies that can beset labor contracting, the workforce in typical firms is too heterogeneous in its interests to make an effective governing body – and the problems are magnified greatly when employees must share governance with investors, as in codetermined firms. In general, contractual devices, whatever their weaknesses, are (when supplemented by appropriate labor market regulation) evidently superior to voting and other collective choice mechanisms in resolving conflicts of interest among and between a corporation’s investors and employees.8 Today, even inside Germany, few commentators argue for codetermination as a general model for corporate law in other jurisdictions. Rather, codetermination now tends to be defended in Germany as, at most, a workable adaptation to local interests and circumstances or, even more modestly, as an experiment of questionable value that would now be politically difficult to undo.9 C. The State-Oriented Model Both before and after the Second World War, there was widespread support for a corporatist system in which the government would play a strong direct role in the affairs of large business firms to provide some assurance that private enterprise would serve the public interest. Technocratic governmental bureaucrats, the theory went, would help to avoid the deficiencies of the market through the direct exercise of influence in corporate affairs. This approach was most extensively realized in post-war France and Japan. In the United States, though there was little actual experimentation with this approach outside of the defense industries, the model attracted considerable intellectual attention. Perhaps the most influential exposition of the state-oriented model in the Anglo-American world was Andrew Shonfield’s 1967 book Modern Capitalism, with its admiring description of
French and Japanese style indicative planning. o The strong performance of the Japanese economy, and subsequently of other state-guided Asian economies, lent substantial credibility to this model even through the 1980s The principal instruments of state control over corporate affairs in corporatist economies have generally lain outside of corporate law. They include, for example, substantial discretion in the hands of government bureaucrats over the allocation of credit foreign exchange, licenses, and exemptions from anticompetition rules. Nevertheless corporate law also played a role by, for example, weakening shareholder control over corporate managers(to reduce pressures on managers that might operate counter to the preferences of the state) and employing state-administered criminal sanctions rather than shareholder-controlled civil lawsuits as the principal sanction for managerial malfeasance (to give the state strong authority over managers that could be used at the governments discretion) But the state-oriented model too has now lost most of its attraction. one reason is the move away from state socialism in general as a popular intellectual and political model Important landmarks on this path include the rise of Thatcherism in England in the 1970s Mitterand's abandonment of state ownership in France in the 1980s, and the sudden collapse of communism nearly everywhere in the 1990s. The relatively poor performance of the Japanese corporate sector after 1989, together with the more recent collapse of other Asian economies that were organized on state corporatist lines, has now discredited this model even further. Today few would argue that giving the state a strong direct hand in corporate affairs has much normative appeal D. Stakeholder Models Over the past decade, the literature on corporate governance and corporate law has sometimes advocated"stakeholder models as a normatively attractive altemative to a strongly shareholder-oriented view of the corporation. The stakeholders involved may be employees, creditors, customers, merchants in a firms local community or even broader interest groups such as beneficiaries of a well-preserved environment. The stakeholders it is argued, will be subject to opportunistic exploitation by the firm and its shareholders if corporate managers are accountable only to the firms shareholders; corporate law must therefore assure that managers are responsive to stakeholder interests as well While stakeholder models start with a common problem, they posit two different kinds of solutions. One group of stakeholder models looks to what we term a fiduciary' model of the corporation, in which the board of directors functions as a neutral coordinator 10. Andrew Shonfield. MODERN CAPITALISM: THE CHANGING BALANCE OF PUBLIC AND PRIVATE POWER(1967)
10. Andrew Shonfield, MODERN CAPITALISM: THE CHANGING BALANCE OF PUBLIC AND PRIVATE POWER (1967). 7 French and Japanese style “indicative planning.”10 The strong performance of the Japanese economy, and subsequently of other state-guided Asian economies, lent substantial credibility to this model even through the 1980s. The principal instruments of state control over corporate affairs in corporatist economies have generally lain outside of corporate law. They include, for example, substantial discretion in the hands of government bureaucrats over the allocation of credit, foreign exchange, licenses, and exemptions from anticompetition rules. Nevertheless, corporate law also played a role by, for example, weakening shareholder control over corporate managers (to reduce pressures on managers that might operate counter to the preferences of the state) and employing state-administered criminal sanctions rather than shareholder-controlled civil lawsuits as the principal sanction for managerial malfeasance (to give the state strong authority over managers that could be used at the government’s discretion). But the state-oriented model, too, has now lost most of its attraction. One reason is the move away from state socialism in general as a popular intellectual and political model. Important landmarks on this path include the rise of Thatcherism in England in the 1970s, Mitterand’s abandonment of state ownership in France in the 1980s, and the sudden collapse of communism nearly everywhere in the 1990s. The relatively poor performance of the Japanese corporate sector after 1989, together with the more recent collapse of other Asian economies that were organized on state corporatist lines, has now discredited this model even further. Today, few would argue that giving the state a strong direct hand in corporate affairs has much normative appeal. D. Stakeholder Models Over the past decade, the literature on corporate governance and corporate law has sometimes advocated “stakeholder” models as a normatively attractive alternative to a strongly shareholder-oriented view of the corporation. The stakeholders involved may be employees, creditors, customers, merchants in a firm’s local community, or even broader interest groups such as beneficiaries of a well-preserved environment. The stakeholders, it is argued, will be subject to opportunistic exploitation by the firm and its shareholders if corporate managers are accountable only to the firm’s shareholders; corporate law must therefore assure that managers are responsive to stakeholder interests as well. While stakeholder models start with a common problem, they posit two different kinds of solutions. One group of stakeholder models looks to what we term a “fiduciary” model of the corporation, in which the board of directors functions as a neutral coordinator
