1.

The Characteristics, Purpose, and Nature of the Corporate Enterprise

The Corporate Form
1) Four Distinct Factors that motivate business owners to conduct as corporations
a) Limited liability of shareholders
i) Investors have no liability beyond the purchase price paid for shares.
ii) Insulates investors’ personal assets from corporate debts.
b) Perpetual Existence of Corporation
i) Corporation constitutes its own legal entity.
ii) Typically enjoys perpetual existence of its charter, remaining unaffected by
shareholders’ status.
c) Free transferability of ownership interests
i) Free transferability of shares makes possible secondary markets in which investors
can trade ownership interests on a regular, continuing, and impersonal basis
ii) Secondary securities markets also gives investors greater liquidity and makes it easier
for corporations to raise capital.
d) Centralized Management
i) Shareholders’ authority is delegated to elected agents, i.e. the board of directors.
ii) The board holds the authority to exercise corporate powers and direct the business
and affairs of the enterprise.
iii) The board can’t be instructed to take any specific action by shareholders and may be
removed only for cause pending the next election of directors.
2) Corporation’s Participants.
a) Directors
b) Officers/Managers
c) Shareholders
A Brief History of the Corporation
a) Early Grant/Concession Theory
a. In the early middle ages, under the concept of divine authority, God created the
Church in an effort to organize and harmonize society. The Church in turn was
the sole body empowered to concede to individuals the right to create lesser
entities or associations.99 Thus, an entity existed only through a grant of leave
from the Church.
b. European Kings subsequently decided they had the same authority as the Church,
and various organizations too could be created only with leave from the King or
Parliament
i. In essence, these charters essentially established outreach of the
government in a geographical area, rather than purely a business endeavor,
since they conducted state’s business (regulate trade, organize trade terms,
establish local government, control customs, conduct foreign policy.)
ii. Thus, the early corporation was extension of state, since, even though they
looked to earn profit, the primary purpose of these corporate charters was to
advance the political interests of the Crown by serving as regulatory bodies
for their respective trades
iii. These charters also prevented conjurations and conspiracies
c. Examples: Massachusetts Bay Colony, East India Company, Virginia Company,
trade guilds
b) Concession Theory in America
a. As in England, the American corporation was viewed as a creation of the state by
virtue of its grant of a corporate charter.
i. “Corporations possess only those properties that the charter confers upon
it.” Trustees of Dartmouth v. Woodward.
b. These charters were often reserved for those activities promoting the public good,
despite being privately owned. This bias in favor of quasipublic corporations
arose in part out of the belief that the performance of a public service was deemed
to be a precondition for the grant of a corporate charter. This is not to say that
the entities themselves were public or necessarily had public powers; rather, the
early American corporation was private but received its charter in exchange for
performing a public service.
c) Democratizing The Corporation
a. Jacksonians disliked special privileges, and they largely associated the corporate
charters that had been granted by colonies with these special privileges.
b. In response to such concerns, the Court in declared a corporate charter did not
imply the grant of a monopoly or other special privilege, and, therefore, did not
prohibit the legislature from granting a rival charter. Charles River Bridge v.
Warren Bridge
c. Two related developments threatened the corporation's special status under the
grant or concession theory.
i. First, special charters were replaced by general incorporation statutes in
which any person(s) who drew up a corporate charter containing the
proper elements, filed it with the secretary of commonwealth, paid proper
fee could engage in corporate activity.
1. Mid 19th century-alongside special charters
2. Late 19th century-exclusive
ii. Second, and perhaps because of the first development, individuals began
to select the corporate form to conduct business.
1. In this model:
a. The corporate form no long was extension, and
b. No longer maintained public mission, and
c. Corporations viewed as a type of partnership, rather than
entity of the sovereign, since anyone can now incorporate
for any lawful purpose.
d. New tendency developed to view shareholders as corporate owners, because the
people who previously organized as owners in a partnership became shareholders
in corporations
e. Thus, the law tended to develop in ways which protect shareholders’ interests to
the extent of the new democratization of the corporation.
d) The Rise of Large Corporations
a. While earlier businesses were motivated to seek a corporate charter because of
the quasipublic nature of their activities, the corporate form was particularly
attractive in the latter half of the nineteenth century for capital-intensive
businesses in search of a way to bring on new investors due to the four
corporate characteristics .
 b. Along with the increase in the size and complexity of the corporation, there was a
decline of the partnership or aggregate theory among legal scholars of the late
nineteenth century.
c. At the same time that the partnership theory's value was declining as a
descriptive tool, the nascent real or natural entity theory began to influence the
academic understanding of the corporation. Whereas the aggregate theory
trumpeted the role of the individual in the development of the corporation, the
natural entity theory viewed the corporation as greater than the sum of its parts.
As such a natural entity, the corporation was ostensibly both entitled and subject to the
same treatment as an individual.
e) Twentieth Century Corporation
a. Secondary Markets Emerge
i. Primary market refers to the corporation’s sale of shares to shareholders
ii. Secondary markets refers to the subsequent sale of shares between
shareholders.
b. Secondary Markets Emerge making large scale trading possible.
i. Industrial revolution required large capital. The government had no
interest in gathering taxes, so the revolution demanded capital be gathered
from large numbers of people
ii. The corporate form was ideal for gathering large capital for four aspects of
the corporate form.
Differing Views on Corporation’s Form
a) The Natural Entity Theory
(1) The natural entity theory suggests that the corporation, in the context of the
reasons for its growth in popularity, is a natural entity which held powers in trust for
the entire community. So, it must balance interests of other constituencies against
shareholders. (note that this is the Merrick Dodd perspective)
(i) Most of the shareholders are really only interested in wealth maximization
and do not necessarily represent the corporation’s long term interests.
(ii) Must account for externalities: impact of contractual relationship on
groups who are not directly parties to corporate negotiations.
b) Shareholders as Residual Claimants
(1) Shareholders are corporation’s owners, and executive is their employee who has
responsibility to conduct business in accordance with their interests, i.e. maximize
profit. (note that this is the Friedman perspective)
(2) Why?
(a) As residual claimants, shareholders are the last people to get paid, so they are
the only group with intrinsic interest to maximize overall corporate value and
thus realize economic efficiency.
(b) Moreover, they can assert claims only through control of the company, while
stakeholders are typically protected by contract and other people should be
protected by government regulation.
(3) While constituency statues instruct directors to consider other constituencies’
interests in exercising their power, they are largely either discretionary or
nonexistent in many states.
(4) Counter-arguments to the shareholder primacy argument
 (a) Contracts relied on by stakeholders are invariably incomplete
(b) Government may not fulfill its regulatory duties concerning externalities.
(c) Fiduciary duties should shift to creditors when corporation nears insolvency
since it will take riskier propositions in which the downside will be borne by
the creditors
(i) Delaware S.C. ruled that, first, creditors can’t assert a direct claim for
breach of fiduciary duty against directors, and, second, they couldn’t
bring directive action. However, when corporation is insolvent, it
creditors have standing to maintain derivative claims against directors
on behalf of the corporation for breach of fiduciary duty.
c ) Statutory Provisions
1. ALI Principles on Corporate Governance
a. Corporate must always obey the law
b. Corporate may devote “reasonable” amount of resources to public
welfare, humanitarian, educational, and philanthropic purposes, even
without direct benefit to the corporation.
c. Ethical considerations, reasonably regarded as appropriate response to
the appropriate conduct of business, are only permissive.
2. State Statutory variation
a. Statutes where corporation has power to make donations for the public
welfare or for charitable, scientific, or educational purposes.
b. Statutes where 1) charitable contributions authorized that further the
business and affairs of the corporation, and 2) philanthropic donations
for charitable, scientific, or educational purposes are allowed
c. Charitable contributions allowed regardless of specific corporate
benefit.
d) Bearle Means Hypothesis
(1) When discussing the merits of various forms of corporate governance, we often
view the shareholders as a single group and everyone else as another single group
(a) The Berle Means hypothesis suggests corporate management should be
viewed as an independent entity with its own interests
(b) Why?
(i) Diffusion in shareholder ownership has resulted in a separation of
ownership and control under which corporate managers can pursue their
own interests largely unconstrained by shareholder opposition.
a. Underlying this premise is that corporate managers seek profit
satisfice, rather than profit maximization, meaning they seek level
of profits sufficient to ensure operation of firm interference free
from shareholder or creditor revolt.
(c) Agency Cost Model Solution
(i) Shareholders are principals who delegate discretion to managers, their
agents, and can control them through 1) establishing incentives (i.e. stock
options) 2) creating monitoring controls (i.e. independent auditing and
outside directors) 3) bonding devices by which agents implicitly guarantee
their own performance (i.e. volunteering to base salaryon the firm’s profit
performance).
(ii) Principals must set optimal level of expenditures for these purposes.
So, a certain degree of managerial misbehavior must be accepted as
“agency cost,” which is the sum equivalent of (a) the residual misbehavior
whose prevention would be too costly, (b) the monitoring expenses
incurred by shareholders, and (c) bonding expenses.
(iii) The debate becomes whether agency costs are best minimized by
corporate legal reforms increasing regulatory control or institutional
reform reduce agency costs or voluntarily adopted monitoring controls and
incentives