The Failure of Corporate Law Fundamental Flaws and Progressive Possibilities

Acknowledgments ix Introduction 1part one Fundamental Flaws 7 1 September 11 and Corporate Law 9 2 Corporate Law as Public Law 29 3 Workers, Shareholders, and the Purpose of Corporations

o f c o r p o r ate l aw

the university of chicago press

chicago & london

is professor of law at Boston College Law School.

The University of Chicago Press, Chicago 60637

The University of Chicago Press, Ltd., London

© 2006 by The University of Chicago All rights reserved Published 2006 Printed in the United States of America

15 14 13 12 11 10 09 08 07 06 1 2 3 4 5

isbn- 13: 978-0-226-30693-3 (cloth : alk paper)

isbn- 10: 0-226-30693-3 (cloth : alk paper) Library of Congress Cataloging-in-Publication Data

Greenfield, Kent.

The failure of corporate law : fundamental flaws and progressive possibilities / Kent Greenfield.

p cm.

Includes bibliographical references and index.

1 Corporation law—United States 2 Corporate governance—United States.

3 Industrial management—United States I Title.

Acknowledgments ix Introduction 1

part one Fundamental Flaws 7

1 September 11 and Corporate Law 9

2 Corporate Law as Public Law 29

3 Workers, Shareholders, and the Purpose of Corporations 41

4 Corporations and the Duty to Obey the Law 73

5 Democracy and the Dominance of Delaware 107

part two Progressive Possibilities 123

6 New Principles, New Policies 125

7 Corporate Governance as a Public Policy Tool 153

8 Workers and Corporate Fraud 187

9 Irrationality and the Business Judgment Rule 217

Postscript: Getting Real about New Possibilities 241

Notes 245 Index 277

This book is the product of more than a decade of teaching and writing inthe area of corporate law Throughout this time, I have been a member ofthe faculty of the Boston College Law School I could not have completedthis work without the support and good counsel of my colleagues, many

of whom have dedicated numerous hours assisting me in thinkingthrough the issues discussed here I am proud to be associated with such

a fine institution and with such an incredible group of colleagues I alsowant to acknowledge Boston College Law School Dean John Garvey, for-mer Law Dean Aviam Soifer, and former Boston College Academic VicePresident John Neuhauser, all of whom supported my research and writ-ing throughout their tenure in leadership positions at Boston College.Many of the arguments put forth in the book were first developed andtested in classrooms at BC Law School Insofar as my arguments are per-suasive, it is because they were tested against the intellect of students whocan be counted among the best, brightest, and most dedicated in thecountry Particular thanks go to my research assistants over the pastseveral years: Michael Carney, Catalina Girald, Kate Devlin, AmandaGordon, John Hong, Scott LaFranchi, Travis Norton, Samuel Price, JasonRadford, Lauren Schumer, Lawrence Sheh, and Christine Westbrook.Thanks, also, to my editors at University of Chicago Press, particularlyAlex Schwartz, who quickly recognized that something in this project was

worth pursuing I much appreciate his support and encouragementthroughout.

A coauthor of mine deserves special mention John E Nilsson was astudent at BC when he and I started working together on a project usingDickens to analyze aspects of corporate law We eventually published a

piece entitled Gradgrind’s Education: Using Dickens and Aristotle to

Understand (and Replace?) the Business Judgment Rule,63 Brooklyn L.Rev.799 (1997) John’s work was essential to the success of that article.Aschapter 9 in this book was derived in part from that article,it is important

to acknowledge here John’s excellent contributions to our earlier tive work

collec-Portions of this book spring from articles I published previously.Chapter 1 is similar to September 11 and the End of History for Corporate

Law,76 Tulane L Rev 1409 (2002) Chapters 2 and 7 are derived in part

from Using Behavioral Economics to Show the Power and Efficiency of

Corporate Law as a Regulatory Tool,35 U.C Davis L Rev 581 (2002).Chapter 3 is based on The Place of Workers in Corporate Law, 39 B.C L.

Rev.283 (1998) Chapter 4 is based on Ultra Vires Lives! A Stakeholder

Analysis of Corporate Illegality (With Notes on How Corporate Law Could Reinforce International Law Norms),87Va.L.Rev.1279 (2001).Chapter 5 is

based on Democracy and the Dominance of Delaware in Corporate Law,67

J Law & Contemp Prob.135 (2004).Chapter 6 derives from New Principles

for Corporate Law, 1 Hastings Corp L.J (2005) Chapter 8 is based on The

Unjustified Absence of Federal Fraud Protection in the Labor Market,107Yale L.J.715 (1997).Chapter 9 is derived from Gradgrind’s Education: Using

Dickens and Aristotle to Understand (and Replace?) the Business Judgment Rule (with John E Nilsson),63 Brooklyn L Rev 799 (1997) I thank thesejournals for their excellent assistance in the editing of the original articles.Portions of this book have been presented at faculty workshops

at the law schools of Fordham University, Georgetown University,Georgia State University, Hofstra University, Loyola University (LosAngeles), Quinnipiac University, Roger Williams University, SeattleUniversity, University of California at Los Angeles, University ofConnecticut, University of Georgia, University of Limerick, YeshivaUniversity (Benjamin N Cardozo School of Law) and at Brooklyn LawSchool I thank the participants at those workshops for their substantialcontributions I also have gained much in discussions with other partici-pants in Corporation 2020 (corporation2020.org), a group of scholars,activists, and business leaders analyzing and redesigning the corporateform

Finally, as any author can attest, a book is never the work of one person.

I have benefited immeasurably from a host of friends, colleagues, andfamily members on whom I have depended intellectually and emotion-ally during the development of this project The book would have been animpossibility but for them, and I am deeply indebted to them I especiallywant to acknowledge and thank: Jeff Bercuvitz, Victor Brudney, MichaelCassidy, Linda Caswell, Daniel Coquillette, Lawrence Cunningham,Nicholas Georgakopoulos, Janet Gilmore, Phyllis Goldfarb, Kirk Green-field, Liam Greenwell, Don Hesse, Daniel Kanstroom, Robert Katz, PeterKostant, Dana McSherry, Lawrence Mitchell, Jane Moscoe, Joseph Singer,David Souter,Kara Suffredini,Kellye Testy,Greg White,and Adam Winkler

I dedicate this book to Barbra and Harold Greenfield, my parents Theygave me the gift of expecting me to think for myself

The achievements of this book I share with all of these, and with manystill unmentioned The failures are mine alone

Melrose, Mass.November 2005

My son, Liam, and I were playing some time ago in Boston’s PublicGardens, near the statues of the main characters in the children’s book

Make Way for Ducklings Liam, who at five was constantly trolling for new

words, turned to me and asked what the word “public” meant I told himthat if something is “public,” it belongs to everyone

If I gave a similar answer to the students in my corporate law course, Iwould be lying When used in connection with corporations, the word

“public” means that they are owned by shareholders who buy and sell theirshares in an open market “Public”corporations are not public in any sense

of having responsibilities to society, or of being owned by the community,

or of being subject to particularly stringent public oversight In fact,

man-agers of most large,“public” companies are prohibited by law from taking

into account the interests of the public when making decisions, if in sodoing those of the company’s shareholders are harmed

This was not always the case For much of the history of the UnitedStates, “public”corporations were deemed to have important civic respon-sibilities At the beginning of the twenty-first century, however, “publiccorporation” is among the most misleading terms in all of law or business

In my view, the public should have a much greater say in how tions are governed Notwithstanding the terminology, public corporationsare typically seen as private institutions, and the law governing them is

corpora-considered a branch of private law (along with contract and property

law), which governs relationships among individuals But the laws trolling corporations should be much more protective of the public goodand of the corporation’s stakeholders, such as employees, and the law of

con-corporations should be evaluated more as a branch of public law, the kind

of law that concerns society more generally, such as constitutional law orenvironmental law Once corporate law is correctly seen as public law, itwill be clear that significant changes should be made

At first glance, it may be difficult to grasp the importance of corporatelaw at all, much less the consequence of a shift from a private conception ofcorporate law to a public one The existing law governing large corpora-tions in the United States is fundamentally flawed, and those flaws causewide-ranging and serious harms in the United States and elsewhere Theseharms include not only the corporate scandals that periodically come tolight, but broader harms such as artificially low wages for working people,environmental degradation, and an even higher risk of terrorist attacks.They could be avoided, however, since the defects that cause them are nei-ther inherent nor essential in corporations or in corporate law We couldchoose to excise these flaws and still have a vibrant economy that createswealth Indeed, the United States could choose to organize corporationsdifferently in a number of ways, and—if the right choices were made—most of us would be better off

The difficulty is that these flaws, while not inherent in the way we dobusiness in this country, do indeed lie at a very foundational level and areoften insulated from attack One example of this kind of defect is share-holder supremacy, the rule that managers of a corporation must pursueshareholder benefit above all else This rule goes largely unquestioned inmost texts used in law schools, even though it creates a gladiatorial cul-

ture within businesses that makes corporate scandals more likely and makes it less likely that corporations will take into account the concerns of

other stakeholders (say, those of workers for more stable jobs) or the lic interest (say, in safer air travel, healthy food, or clean skies)

pub-Other aspects of corporate law, though terribly flawed, are lauded as

beneficial aspects of corporate governance.An example is the dominance

of the state of Delaware in providing the laws of corporate governance.Six

of every ten of the nation’s largest corporations choose to incorporate inDelaware Because of a legal rule called “the internal affairs doctrine,”Delaware gets to set the rules of corporate governance for those compa-nies, even though most of the companies have little or no connection tothe state other than filing their incorporation papers there The result is

that a state with less than one-third of1 percent of the nation’s population

is allowed to govern a majority of the nation’s most powerful businesses.The mainstream view among contemporary corporate law scholars isthat corporations’ preference for Delaware law shows that Delaware isoffering the best, most efficient law available If the corporations didn’tlike the law Delaware provided, they would simply incorporate elsewhere.This creates a “race to the top,” ensuring that states compete to providegood law, to everyone’s benefit

The more likely story is that corporations prefer Delaware law notbecause it is most efficient but because Delaware offers corporations away to bypass democratic pressures and to export the costs of its legalstructure to other states Delaware’s dominance is hardly a testament toefficiency It is rather a product of legal rules that are wrongheaded, inef-ficient, and undemocratic

In this book I will catalog these and other core failures of traditionalcorporate law, but deconstruction is not the sole goal In addition, I willspell out some concrete proposals for changes in the law governing cor-porations I will argue that these changes will not only make corporate lawmore coherent (certainly a goal for law professors if for few others) butalso more beneficial to society generally Indeed, I will suggest that corpo-rate governance law should be seen as a regulatory tool, and a powerfulone at that, to address some policy problems that have otherwise beenquite intractable over the years Concretely, I will argue that improve-ments in corporate governance would have positive impacts on (at least)two of the knottiest economic problems of the last 20 years: stagnantwages for blue-collar workers and stark income inequality In otherwords, corporate law has great promise, if we can harness it as a progres-sive force

In making these arguments, I will use concrete examples and evidence

to bolster the persuasiveness of the new ideas set out here Throughoutthis book I not only use theoretical and logical argument but also look atcases, economic statistics, and behavioral science to build the argumentthat the existing framework is fundamentally flawed and that a differentframework holds promise of great improvement Beyond these, however,

I do not attempt to amass a comprehensive set of empirical data necessary

to convince readers who are unmoved by theory For some of the ments made here the empirical research simply has not been done; forother questions the research is only beginning In any event, it is not thepurpose of this book to catalog empirical data on corporate governanceregimes Rather the purpose of this book is to expose the flaws of main-

argu-stream corporate law theory and to argue the reasonableness of an native theory that would likely create outcomes that are more democraticand more beneficial.

alter-My focus on theory will beg comparison with the leading defense ofthe mainstream, law-and-economics view of the corporation, Frank

Easterbrook and Daniel Fischel’s The Economic Structure of Corporate

Law Published in 1991, Easterbrook and Fischel’s book was the definitivetheoretical account of corporate law from a neoclassical, contractarianperspective It has had a huge impact on the scholarship, pedagogy, anddoctrine of corporate law, becoming perhaps the most significant book

in the field since Adolf Berle and Gardiner Means’s 1932 master work

The Modern Corporation and Private Property In fact, the impact of

Easterbrook and Fischel’s book is such that it has become one of the most

cited books in all of law, in any area of doctrine, in the last 25 years.1

Though countless scholars have used it as both a starting point or target,there has never been a comprehensive, theoretical response to Eas-terbrook and Fischel from the stakeholder perspective This book is in-tended to fill that gap

Easterbrook and Fischel’s analysis depends on legal and economic ries, and, in answering them, my style is similar for the most part But itwould be a mistake to have the debate be only about theory The argumentshere, and the arguments of the mainstream corporate law theorists, should

theo-be tested If this book is sufficiently persuasive to bring into doubt the stream view so that scholars will test my arguments against those in defense

main-of the status quo, then this book will have been a success

This book comes at a moment of significant intellectual ferment amongscholars who study corporations While the mainstream view of corpora-tions and corporate law continues to hold sway in most court opinions and

at the most prestigious law schools, a growing number of scholars arecontesting some of the basic tenets of the dominant school.Disagreements

go to the heart of the discipline: what corporations are; who owns them;whether they are public or private institutions; whether managers should

be charged with maximizing profits only or taking care of other socialgoals There is now more disagreement than perhaps in any other area oflaw, and the disagreement is at the very core of the discipline

The question is, of course, so what? Why should anyone care who doesnot teach or work in the area? The answer is that corporate law deter-mines the rules governing the organization, purposes, and limitations ofsome of the largest and most powerful institutions in the world The

largest corporations in the world have the economic power of nations Byestablishing the obligations and priorities of companies and their man-agement, corporate law affects everything from employees’ wage rates(whether in Silicon Valley or Bangladesh), to whether companies will try

to skirt environmental laws, to whether they will tend to look the otherway when doing business with governments that violate human rights.Corporate law is a big deal And it is an even bigger deal when one real-izes that the United States is actively exporting its corporate governancenorms to the rest of the world by way of the World Trade Organization, theOrganization for Economic Cooperation and Development, and varioustrade agreements If U.S corporate law is flawed in our own society andculture, as I believe it is, imagine the difficulties that will arise as thisflawed regime is transplanted elsewhere

The purpose of this book is to provide grounds to challenge the nant vision of corporate law in the United States and the other countrieswhere our corporate law is being adopted I intend to show how changingcertain foundational assumptions about corporations and the law thatrules them would have meaningful implications for how we think aboutcorporations and corporate power I will also propose concrete, achiev-able adjustments to law and policy that would create real, positive change

domi-My central claim in this book is that most of us in the United States, aswell as many people throughout the world, would be better off if corpo-rate law were different.We could have better jobs and more money in ourpockets; our rivers and beaches and skies could be cleaner; we could besafer from crime and terror Our food could be healthier; the products webuy could be more reliable.We could trust our employers—and indeed ouremployees—more; our communities could be stronger; our politics could

be cleaner The changes I propose are not panaceas, of course But thedebate over corporate law is much more important than most people real-ize, and it should be the concern of more than corporate lawyers and cor-porate law professors Indeed, that corporate law matters is this book’smost audacious claim

part one

f u n da m e n ta l fl aws

Much has been written over the past several years about the problemswith corporations and how they are regulated The corporate scandals ofthe first few years of the twenty-first century were serious enough to cre-ate widespread concern about the accountability of corporations in the

United States Time and Newsweek ran cover stories; prosecutors brought

high-profile cases against miscreant executives; art-house cinemas playeddocumentary films revealing the excess of corporate power.1

These efforts to critique America’s business culture are not new or ticularly surprising This nation has seen a number of periods in whichcorporations were the object of popular criticism and distrust, includingthe late nineteenth-century populist attacks of William Jennings Bryanand Theodore Roosevelt, the New Deal of the 1930s, and more recently inthe anti-multinational and pro-environment movements of the 1960s and1970s.A key difference between these earlier eras of discontent and today

par-is that the earlier critiques depended on not only political and culturalattacks but on scholarly condemnation as well Today a populist critique

of corporate power and globalization is taking hold, but scholars, ularly legal scholars, lag behind Even though the recent corporate scan-dals revealed widespread discontent about the power of corporations inAmerica, most corporate law professors in most American law schools

partic-continue to teach corporate law the way it has been taught for decades,seldom questioning its fundamental assumptions.

Part 1 highlights several fundamental assumptions that deserve thinking These include the corporation’s fixation on profit; the propen-sity of the firm to cast the costs of its behavior onto others; and thewidespread notion that corporate law is private law, presumptively free ofgovernment regulation Also critiqued here is the law’s requirement thatthe shareholders reign supreme and the workers be seen only as hiredhands This part also questions the notion implicit in corporate law doc-trine that corporations do not have the same obligation to obey the law asthe rest of us The last chapter in part 1 focuses on the bizarre fact thatDelaware is almost completely dominant in providing the corporate law

re-of the United States and questions whether such dominance is ically legitimate

democrat-Of course, this list is not exhaustive of the foundational assumptionsthat deserve dismantling But it is a good start, and changing even thesefew would give the nation an excellent shot at taking some of the positivesteps set out in part 2

At first glance, it seems obtuse or heartless to talk about corporate law

in connection with the attacks of September 11 and the war in Iraq It isindeed obtuse or heartless to say that corporations or corporate law

caused the events of September 11 or brought about the war.It is,however,correct to say that corporations and corporate law helped create both thecontext in which the tragedy of September 11 could occur and the con-tours of the nation’s response to it Corporate law made the tragedy ofSeptember 11 more possible, and thus made the war in Iraq more likely

as well This connection between corporate law and the attacks ofSeptember 11 is a worthy case study in the flaws of U.S corporate gov-ernance.

september 11 as market failure

Soon after the attacks, many analysts pointed fingers at slipshod airportsecurity as one of the necessary conditions for the attacks It may be unfair

to assert that the security personnel working at the airports from whichthe hijacked flights departed had failed in their jobs in the strict sense ofthe word The hijackers used pocket knives and box cutters to hijack theplanes, neither of which was prohibited by airline regulations at the time.Having said that, it does not require a leap of logic to assert that the hijack-ings could have been prevented by a more attentive security staff (is it notunusual to have several passengers carrying box cutters on the sameflight?) or security regulations or policies that made safety a higher prior-ity (why did airlines not bar passengers from carrying box cutters?) Sothe question arises: why was security so porous that morning?

One possible answer would be that security was flawed that morningbecause air travelers did not want or feel they needed anything better.Airport security on September 11 was largely the responsibility of the air-lines and of security firms the airlines hired Because airline companiesare for-profit corporations operating in a “free market,” traditional eco-nomic theory would suggest that the market provided what the con-sumers desired If travelers had truly wanted more safety, they would havedemanded it and the airlines, in turn, would have given travelers whatthey demanded The cost of airfares would have necessarily increased topay for the additional security To traditional economists, the fact thatsecurity was not any better on that day means simply that the airlines’cus-tomers were not willing to pay what it would cost to have the kind ofscreening that would deter the hijackings

If this economic theory is correct, the correct public policy response toSeptember 11 would be to trust the market If people wanted to have bet-ter airport security, they would demand it Air travelers willing to paymore in exchange for additional safety would provide the economicincentive for airlines to respond to travelers’ desires, and airlines wouldstart competing to provide additional safety and security

It is striking that among all the major investigations and analyses of thehijackings, not a single one proposed that we should simply allow themarket to work Instead, the very first public policy response to the hijack-

ings was just the opposite Barely two months after the attacks, Congressvoted to federalize the passenger screening function, taking that portion

of the responsibility for airport security away from the airlines and giving

it to a newly created federal agency

Of course, anyone who travels knows that the new agency is not out its own problems—going through airport security remains a frustrat-ing, inefficient, and occasionally infuriating task No one has seriouslysuggested, however, that the security function be given back to theairlines Few trust the economic theory that much Even though we knowthe government agency has its own serious flaws, it is as if September 11helped us realize at a fundamental level that we cannot trust airlines toprovide the kind of safety we now know we need

with-This is why September 11 is not only a story of how fanatic zealotscommitted murder on a grand and horrific scale It is also a story of mar-ket failure, of how the market for air travel failed to provide not only what

we needed but also what we would have wanted had we known howunsafe we really were This begs the question, then, of why such a marketfailure occurred Why did the airlines not provide better safety? Or morefundamentally, why did the free market not provide better safety?

To answer these questions one needs to recall that the airlines tracted out the responsibilities of staffing the security checkpoints to pri-vate, for-profit security firms These firms bid on these contracts on thebasis of cost It is no surprise, then, that the screening firms paid theirworkers little more than minimum wage, which made it difficult to attractthe best people Turnover among screeners averaged over 125 percentannually, meaning that on average a new person was hired for every posi-tion more than once per year.1Because of the low pay, many of the screen-ers had to work at some other job as well, making them exhausted andunable to concentrate effectively Many of the contractors did not offer

con-health insurance or paid sick days As a result, according to the New York

Times, “many screeners report[ed] to work sick and struggled to remain

alert.”2The fixation on keeping costs low meant that training of point screeners often consisted of little more than watching a videotapeand receiving about one hour of on-the-job training A governmentreport issued barely 18 months before September 11 warned that thescreeners’low pay, poor training, and high turnover posed real risks to thesafety of air travel.3

check-Sadly, the risks were largely ignored until it was too late Only after thetragedies of September 11 did people finally realize that the fixation on lowcosts was a massive error

It is worth thinking about why screeners’ wages were so low to beginwith One thing is clear, at least in hindsight: wages were not low becausetravelers were unwilling to pay a few dollars more for airline tickets so thatthe security firms could pay for good training and decent wages forscreeners In this respect, the market failure was in large part an informa-tion failure Most people who traveled simply did not know the risks anddid not know how flawed the screening was To use myself as an example:Before September 11, 2001, I did not know that airport security was theresponsibility of the airlines, and I traveled often I assumed travel wassafe I assumed that someone—the government, really—made sure thatairport security was tight I was mistaken, as many were.

One reason why we did not know that air travel was unsafe was that theairlines themselves did not have the incentive to tell us Because theirinterest was to maximize air travel, no airline had any reason to warn trav-elers that it was possible for teams of fanatics to use box cutters to hijackplanes, fly them purposefully off course for more than an hour, and pro-pel them like missiles into skyscrapers Much of the information aboutthe risks of air travel was in the hands of the airlines, and their desire tomake money meant that there was no way they were going to tell us aboutthose risks

Moreover, even if one of the airlines had wanted to distinguish itself asthe “safe” airline, it would likely have failed The reason is that such mar-keting would have had little meaning to travelers Because most travelersassumed air travel was safe, it would have been difficult to make believ-able claims about the distinctiveness of one airline over another, at leastwithout panicking the traveling public In other words, no one traveling

on September 11 really knew how dangerous it was.Some of the risks were

unknowable, to be sure But the risks that were known were not known by

the travelers, and the market did not provide an incentive to give travelersthat knowledge

The market failure was more than an information failure, however.Even if I had known that screeners were poorly paid and trained and thatsecurity was flawed in other ways, my options would have been ex-tremely limited I could not have volunteered to pay more for my airtravel in exchange for more security A travel agent would have chuckled

at such a request I could not have sought out a safer airline, since all theairlines (at least in the United States) provided basically the same appar-ent level of safety Even if I had known how risky air travel really was, themarket would not have provided me a way to satisfy my desire for a safertrip

What’s more, even if all travelers had wanted safer air travel, it isunlikely that the market would have provided it The only way travelerscould have expressed their preferences in the market would have been tostop buying plane tickets Faced with the decrease in demand, it wouldhave been much easier for the airlines to compete on the basis of pricethan on the basis of safety Improvements in airport screening wouldessentially inure to the benefit of all airlines, and no individual airlinewould benefit more than any other It would have been more cost effectivefor each airline to distinguish itself by offering lower prices or more con-venient schedules.

Similarly, contractors providing the security for the airlines did nothave good incentives to compete for their contracts on the basis of theirability to provide better security Contractors paying their employeesmore to provide better safety would be putting themselves at a competi-tive disadvantage Because safety improvement would be a collectivegood and largely unseen by the ultimate customer, the individual airlineswould be uninterested in paying the contractors more so that they couldpay the screeners more

All this is to say that the market for air travel did not provide, and

prob-ably could not have provided, the level of security we needed Even now,

when air travelers are very much aware of the risks of air travel, airlines inthe United States still are not competing on the basis of safety Theresponsibility for security was moved into the hands of the government,and airlines are competing on the same grounds as before

There is an additional puzzle One wonders why shareholders of United

and American and other airlines failed to demand that the airlines bemore secure In hindsight, better security would likely have been a goodinvestment financially After September 11, airlines suffered dramaticfinancial losses because of the drop in the number of passengers who

were willing to travel by air According to the Wall Street Journal, United

Airlines alone was losing $20 million a day six weeks after the disaster.4

There are a number of reasons why shareholders did not prevent thedisasters Quite likely, many of the airlines’ shareholders simply did notknow that they held airline stock Their shares might have been held intrust, with an institution, or in a pension or mutual fund For those share-holders who did know, it is probable that they held the same assumptions

as the rest of us—that air travel was safe and that there was no need toworry that such a disaster would occur Shareholders might also havebeen making a calculated judgment that greater security would not be agood financial investment, on balance Last, and most likely, shareholders

simply might not have thought about it Shareholders of large publiccompanies are not typically managers—the management of the firm is inthe hands of the board and senior employees Shareholders have little or

no say in specific decisions that a company makes and little or no edge of the management issues a company faces

knowl-But even if shareholders had known of the potential security problemsand wanted to do something about it, they would not have had any moregenuine options than air travelers themselves They could have raised theissue at an annual meeting of the shareholders, but issues about safetywould have likely been seen as management prerogative The only otheroption for concerned shareholders would have been to sell their stock.That would have protected the shareholder from the financial risk of airdisasters But it would not have had any effect on company policy, sincethe company would have no way of knowing that the reason a share-holder sold her stock was to protest poor security

So no one—travelers, shareholders, the airlines, or the screeningfirms—had any real ability to improve airline security by acting throughthe market We had to depend on nonmarket forces, that is, governmentintervention, to correct the flaws in airline security that we learned about

in such a horrible way The market was powerless to provide what we allrealize now we so desperately needed

september 11, externalities, and enablingism

Consider again the position of a hypothetical, fully informed shareholder

in United Airlines before September 11 Because this person had no realway to affect the security of air travel, even knowing it was flawed, the onlyeconomically “rational” reason to hold onto the stock was as a wager thatcheap, imperfect security was a better financial investment than moreexpensive, less imperfect security This would seem a crass calculation.Corporate law adopts the fiction that shareholders make exactly this

type of decision about every stock they own, regardless of whether real

shareholders ever, in fact, are this informed or make such a callous tion Because shareholders can learn about companies from informationfreely available and can sell stock in a fluid securities market, it is assumedthat those who hold a company’s stock voluntarily accept the risk-returnratio It is also assumed that shareholders care about only one thing—mak-ing money Shareholder preferences are assumed to be homogeneous, andthe law and market are arranged to make sure that management hewsclosely to this one assumed concern If shareholders do not like it, they can

calcula-sell their shares (or so the story goes) The notions that shareholders knoweverything important about a firm and care about only one thing arefictions, to be sure But these fictions allow corporations to be characterized

as voluntary, consensual organizations In Easterbrook and Fischel terms,

“the corporation is a voluntary adventure.”5

The assumption of consent does not stop with shareholders Everyoneelse involved in a company—from creditors to employees, from customers

to communities—is also assumed to be consenting to their involvement in

a meaningful way This is what the law-and-economics scholars meanwhen they say a corporation is a “nexus of contracts.” No one is coercedinto taking part in the firm If the parties dislike the terms of the “contract”between themselves and the company, they can leave Not only can share-holders sell their shares, but employees can quit, managers can find adifferent company to manage, suppliers can sell their goods elsewhere,creditors can sell their bonds According to these contractarian theorists,the corporate contract does not affect anyone not a party to it Easterbrookand Fischel make the claim explicitly: “The corporation’s choice of gover-nance mechanisms does not create any substantial third-party effects—that is, does not injure persons who are not voluntary participants in theventure.”6In economic terms, the claim is that the corporate contract doesnot create any “externalities.”

September 11 shows the flaw in this argument.To say that the decisions

of the airlines concerning the safety of air travel did not have any impacts

on anybody “external” to the decision makers of the corporations selves is ludicrous.The bad decisions of the airlines about safety had awfuleffects on thousands who had no real, meaningful way to affect the deci-sion making of the airlines before September 11 Safer air travel wouldhave inured to the benefit not only of the decision makers of the company(managers and shareholders) but also to employees, customers, and,sadly, the workers in the World Trade Center and Pentagon as well as thefirefighters and police officers who tried to save them The people work-ing in the World Trade Center and Pentagon could not have “paid” any-thing for better airline security, nor were they “voluntary” participants inthe airline’s risk-return calculations They were totally and utterly shutout of decisions about airline security

them-Their only route of influence, before the fact, was through the ment And the government had already given the corporations the right

govern-to police themselves on security matters The airlines were trusted govern-toprovide something that they had little incentive to provide, beyond what-

ever minimum level was necessary to make their customers feel secure

(whether they were or not) A host of others affected by decisions aboutairline safety had no meaningful way to have an impact on the decisions.This is the very definition of externalities.

Like airlines, most companies create a huge range of externalities, andsuch a recognition is hardly new My point here, and the point often over-looked, is that the corporate contract itself makes these externalities pos-sible, even likely Legal scholar Lawrence Mitchell calls the corporation an

“externality machine,”7and one of the reasons he is right to call it that isbecause of corporate law By centralizing power in management, limitingthe involvement of other stakeholders in corporate decision making, andimposing a requirement that the firm’s management care about makingmoney first and foremost, the law has created an entity that is guaranteed

to throw off as many costs and risks onto others as it can.8If a corporationcan make money by polluting a river, it will likely do so If a corpora-tion can make money by paying its workers low wages or making themwork in unsafe conditions, it will likely do so If a corporation can makemoney by disregarding the harms of a product—whether a toy, a car, or airtravel—it will likely do so By law and norm, the corporation cares onlyabout making money, and any other goals are set aside unless theyincrease the company’s profit

Instead of creating a governance system that would help internalizethe concerns of customers, employees, or society in general, the system ofcorporate governance in the United States sets up shareholder interests assupreme and centralizes decision making so that those interests areserved Other stakeholders are left to depend on mechanisms outside cor-porate law, primarily in the form of express contracts or government reg-ulation, both seriously imperfect, to protect their interests

Related to the claim that corporate law does not create external costs isthe assertion that everyone’s involvement in a company is voluntary Thisclaim is also crucial to traditional corporate law scholars, who argue thatbecause everyone’s participation is consensual, the law should not set upmandatory constraints but should simply set up default rules aroundwhich people can contract if they so desire This form of law, which shunsstrict requirements and instead enables participants to choose the terms

of the corporate contract that best serve their collective interests, is called

“enablingism.” Most states, in fact, follow this model in establishing porate law

cor-Traditional corporate law scholars applaud enablingism because theysay it allows people to negotiate voluntarily for outcomes that optimizetheir collective well-being Corporate law is seen as carrying with it the

benefits of contract law, which allows individuals to maximize welfarethrough voluntary exchanges The argument is straightforward: no onevoluntarily enters into a contract (whether to purchase a house, to selllabor, or to write a book) unless doing so makes her better off.

In this view, because corporations are seen as an intricate network ofcontracts, the role of corporate law should be limited to the establishment

of default rules that most parties would choose if they actually sat down

at a table and negotiated terms Working from these rules saves time andallows the parties to reach the best outcome with the lowest amount ofeffort In creating the default rules, the government should not place itsfinger on the scale to assist a party in setting the terms of the corporatecontract To do so would move the agreement away from the “optimal”contract—defined as the agreement the parties would reach absentgovernment intervention—or would force the parties to readjust otherterms in the contract to compensate for the advantage imposed by thegovernment According to traditional corporate law scholars, the onething worse than the government stepping in at the formation of the cor-porate contract is government intervention after the terms are set Thegovernment’s intervention would frustrate the parties’ settled expecta-tions and make it even costlier for them to recalibrate their arrangement.9

This justification for enablingism is so appealing that it has been thedominant normative prescription for corporate law for several decadesand has had a significant effect on what the law actually is But there ismuch that is problematic in this account One fundamental problem is thebelief that default rules do not have any real meaning, other than as a start-ing point to negotiation As it turns out, default rules have remarkablestaying power, even when they are not, in fact, what people would negoti-ate in the absence of those rules.10One reason for this is that people takecues about their own behavior and beliefs from what the law suggests.When the law sets shareholders as supreme within the firm, it is muchmore likely that they (and, indeed, other stakeholders as well) will believethat they deserve that superiority That belief will become set, and share-holders will not “pay”for it and the other stakeholders will not challenge it.Another fundamental flaw in enablingism is that it takes as given theappropriateness of utility, measured by the satisfaction of preferences, asthe guiding principle within law in general and corporate law in particu-lar An argument that government should allow negotiating parties tomaximize their collective preferences depends on the notion that thesatisfaction of preferences should be the organizing principle of publicpolicy Of course, whether utilitarianism should be the touchstone for law

is an age-old debate that rages still.11Suffice it to say, however, that rate law, like other areas of the law, could choose to advance publicvirtues—such as human dignity or fairness or compassion or equality orautonomy—in addition to utility.

corpo-The most profound difficulty in the enablingism account is the tion that the corporate contract optimizes the interests of the variousparties to the deal Because law is supposed to stand aside, any contractthat results from a negotiation depends upon the power of the partiesgoing into the negotiation The resulting contract defining the terms ofcorporate governance thus mirrors the preexisting market power of thevarious parties To say that a contract optimizes the interests of the partiesmay be true in that it allows the parties to improve on what would be theirlot without such a contract But it is emphatically not the case that allcontracts are fair, just, supportive of human dignity, or consistent with theinterests of society as a whole Therefore, we should not assume that acontract that depends on preexisting entitlements is just or fair withoutfirst questioning whether those preexisting entitlements—upon whichthe corporate contract is founded—are themselves just and fair.12

asser-After all, this notion that contracts are not always just is self-evident inlarge areas of law In a variety of situations, the law recognizes that con-cerns about fairness outweigh the personal freedom to contract.For exam-ple, in the United States people cannot (even voluntarily) enter intoemployment contracts that pay them less than the minimum wage or willsubject them to systematic racial or sexual harassment.13Nor can anyone(even voluntarily) enter into an employment contract in which they agree

to be exposed to dangerous levels of asbestos The importance of humandignity outweighs a person’s voluntary consent to work as a prostitute, atleast in most jurisdictions These contracts are off limits because the free-dom to contract is outweighed by some competing principle So-calledfreedom of contract is a balance, and we are quite comfortable performingthis balance in most areas of law and policy But however self-evident else-where, many corporate law scholars seem to ignore the concept that pub-lic welfare may include more than the mere satisfaction of preferences.Let me now tie in the notion that corporate law creates externalitieswith the point that corporate law is mostly enabling Because the lawlargely stands aside in the formation of the corporate governance “con-tract,” the parties with power—the shareholders and managers—canagree to whatever arrangement will benefit them They can externalizethe cost of the contract onto those who have less power to do anythingabout it Corporate law reinforces market power rather than ameliorates

it, and those who have less market power to begin with—workers, munities—are cemented into their position If corporate governance isthe area of law where contracting is the most unconstrained by law, it isalso the area of law where market power is most supreme And wheremarket power rules, those with the market power rule.

com-Most corporate law scholars would say that corporate law is not sobiased Corporate law is, instead, “neutral” as to winners and losersbecause it merely gives force to what parties to the corporate contractwould bargain for anyway But that response is simply another way of say-ing that the market is neutral and that law should use market power as thepredominant guide for public policy Such an assertion is highly con-testable and far from neutral

Imagine a politician who advocated that individuals should be freefrom sexual, racial, or sexual orientation discrimination only if they werewilling and able to pay for such freedom Such an argument could hardly

be defended on the grounds that the law was simply choosing a neutralbaseline, market power, as the basis for public policy Moreover, if we didlive under such an unjust legal framework, it would not take an economist

to see that discrimination itself would be an externality of the choice oflegal rule The costs of the legal rule would land predominantly on thosewho had little role in creating it

Similarly, when corporate law scholars argue for legal rules that saythat stakeholders must protect themselves through their contractualrights, that is simply another way of saying that they get only those rightsthey can buy Such enablingism is hardly neutral because it uses the law tobolster the power of those who are already powerful and allows the costs

of the enterprise to be externalized onto the less powerful stakeholderswho have less ability to pay for their own protection

september 11 and the myth of the free market

The rhetoric of enablingism is quintessentially that of the free market andlaissez-faire: the government should simply create the context in whichprivate parties can negotiate to their mutual benefit The aftermath ofSeptember 11 makes it clear that this free-market rhetoric has few genuineadherents and certainly does not describe the society in which we live.First of all, the demand for greater government oversight of air travelreveals that the market cannot be trusted to produce and deliver manythings that people truly desire Corporations may be good at makingmoney, but they are not as capable of providing things that take a long

time to produce, things that cannot be easily reduced to a monetary value,things with benefits that are widely shared, or things that are valued bypeople with no money If the public wants something that fits into one ofthese categories, the government usually has to provide it or encourage itsprovision Government regulation is thus often necessary in order to givepeople what they want.Without government regulation, we would not befree to travel safely, work in a safe workplace, or buy a home in an inte-grated neighborhood.

Indeed, only the most out-of-touch academics really want a “free” ket, and the aftermath of September 11 shows how the rhetoric of the freemarket is just that Remember that traditional corporate law assumes thatshareholders of public companies voluntarily accept the risk-return ratio

mar-of the securities they hold Shareholders are assumed to accept the riskthat the value of their investments will fall, even because of catastrophicevents

Of course, this assumption, that free market forces would rectify thefinancial crisis following the catastrophe, was discredited when, literallyhours after the disaster on September 11, lobbyists for the major airlinecompanies were on Capital Hill asking for massive government assis-tance.14Within weeks, the government bailed out the airlines, to the tune

of $15 billion, and through the fall of 2001 also entertained variousentreaties from travel agents, hotel chains, insurance companies, and evensoybean farmers.15President Bush and his commerce secretary also metprivately with 15 insurance executives, who petitioned the president forfinancial help They made their requests not because the tragedy haddamaged the industry, which had assets of more than $3 trillion, butbecause they worried about future attacks and wanted the government toagree to a cap on any future insurance payouts.16Bush’s willingness tomeet with corporate executives so soon after the tragedy might be ex-plained in part by the fact that the insurance industry had given $1.6 mil-lion to Bush’s 2000 campaign, making it Bush’s tenth largest contributor

In any event, it is quite clear that the insurance executives were not askingfor the government to allow the market to work—they were pleading forjust the opposite

Indeed, it is more than a bit ironic that the free-market contractarianrhetoric is so strong within corporate law scholarship when few firms,executives, or shareholders would sign on to such rhetoric outside thelimited area of corporate governance Rather than being free-marketbelievers, corporations depend mightily on government assistance to sur-vive and make money I speak not only of the billions of dollars a year that

go into export subsidies, price supports, tax concessions, and other ples of “corporate welfare,”17but also of the very infrastructure of themarket, which is in large part a creation of government and governmentregulation Laissez-faire enablingism may be the rallying cry in corporategovernance, but elsewhere corporations want and expect governmentprotection and assistance.

exam-This leads to another aspect of hypocrisy on the part of corporationsand corporate law One of the arguments often made in favor of the doc-trine of shareholder primacy is that other stakeholders of the firm will

be able to protect themselves through the legislative and regulatoryprocesses This argument only works if the stakeholders who are notshareholders have some comparative advantage in the legislative or regu-latory arenas One of the lessons from September 11, however, is that thecomparative advantage, to the extent that one exists, sits on the other side

of the ledger.18After September 11, airlines received billions of dollars ofgovernment money in the bailout but laid off thousands of employees.United laid off20,000 employees while running ads saying “if we sticktogether, we can get through this.”19The airlines had the lobbyists, theadvertisers, and the ear of Congress The employees got pink slips.Another of the public responses to the tragedy was renewed attention

to an economic stimulus plan Less than six weeks after September 11, the

Wall Street Journal reported that the House of Representatives had

sched-uled a vote on an economic stimulus package that would result in the U.S.Treasury sending checks worth hundreds of millions of dollars directly toprofitable corporations Under the plan adopted by a House committee,Chevron could receive over $300 million; General Electric almost $700million, General Motors over $800 million.Incredibly,IBM would receive

a check for almost $1.5 billion, and Ford Motor Company would stand togain over $2.3 billion The Wall Street Journal reported that the proposal

to send lump-sum payments to corporations was added in the HouseWays and Means Committee “with little debate, after quiet and effectivelobbying by U.S multinational companies.”20The free market be damned

september 11 and the end of history

Nine months before the tragedies of September, two of the leading ars in corporate law, Henry Hansmann and Reinier Kraakman, published

schol-an article arguing that the “ideology” of shareholder primacy has become

so dominant in the United States and globally that we are experiencingthe “end of history” for corporate law.21While “end of history” arguments

are audacious, Professors Hansmann and Kraakman’s claims were notfrivolous For much of the past 25 years, most corporate law scholars inthe United States have not challenged the basic underpinnings of the doc-trine, which include shareholder supremacy, the dominance of Delaware,and enablingism This has begun to change in the United States, as a smalland committed group of scholars are stoking debates about these funda-mental premises Nonetheless, as pure description, Hansmann andKraakman’s portrayal is more right than wrong.

Hansmann and Kraakman were not just describing—they were scribing as well They were not just saying that shareholders are supreme

pre-in fact, but also that they should be The aftermath of September 11 helpsreveal the weaknesses of their argument

The arguments for shareholder primacy depend on the notion thatcorporations that look after shareholder interests benefit society morethan those that look after other interests Hansmann and Kraakman makethis point explicitly, saying that “all thoughtful people” agree that businessshould be “organized and operated to serve the interests of society as awhole, and that the interests of shareholders deserve no greater weight inthis social calculus than do the interests of other members of society.”22

This admission is to their credit—since it is not often so expressly knowledged by corporate law scholars—but they never explain why theybelieve shareholder primacy is best for society Their jump from the wel-fare of corporations to the welfare of society is only a slightly moresophisticated way of saying “what is good for General Motors is good forAmerica” and is adduced by way of simple assertion:“The point is simplythat now, as a consequence of both logic and experience, there is conver-gence on a consensus that the best means to this end (that is, the pursuit

ac-of aggregate social welfare) is to make corporate managers stronglyaccountable to shareholder interests and, at least in direct terms, only tothose interests.”23This is simply the trickle-down theory superimposedonto corporate law: what is good for shareholders is good for corpora-tions, and what is good for corporations is good for society

If this connection existed, the shareholder bandwagon would beattractive indeed The problem is that advocates for shareholder primacy

do not purport to say how the connection occurs or test whether the nection is true In fact, the real reasons for shareholder supremacy haveabsolutely nothing to do with any testable assertions that we are better off

con-as a society The most contractarians really say is that we are better off con-as

an economy Hansmann and Kraakman say that comparison across

coun-tries “lends credence to the view that adherence to the standard

[share-holder supremacy] model promotes better economic outcomes.”24Thatview is highly contestable and, even if true, does not prove the point thatneeds to be made Only if one is a strict utilitarian, and a simple-mindedone at that, does one equate success as an economy with success as a soci-ety One can imagine a very affluent society in which people are person-ally and socially insecure, where the poor have almost no chance ofreceiving a decent education, where one-fifth of all children are born intopoverty, where young men of color have a greater chance of spending fouryears in jail than four years in college.25There is little basis to concede theprofessors’ assumed connection when one need only look at a newspaper

to see that affluence does not necessarily equate to broad social welfare.Even if the claim is that shareholder primacy makes macroeconomicsense, much will turn on the particular economic indicator one considers

If evaluating the economy as a whole, shareholder returns cannot be theonly measure One would also have to look at other criteria of economicsuccess For example, one would need to explain why the poverty rate forchildren in the United States, the most developed nation in the world, isover three times the child poverty rate of Germany.26One would need toaccount for the fact that income inequality is worse in the United Statesthan in any other developed nation, is at its worst since World War II, and

is projected to be even more unequal in the near future.27One would have

to come to terms with the fact that over the past thirty years, real wagegrowth in the United States is no better than stagnant By some accountstypical working people in the United States make less in real terms nowthan their parents did during the Nixon administration.28These statisticsnot only reveal the real status of an economy built upon the traditionalshareholder supremacy model, they provide a clue to the range of nega-tive political and social externalities to which that model has turned ablind eye

In contrast, it is worth considering Germany, where shareholder macy is not the norm There, the law requires that companies organizetheir workplaces under the oversight, review, and guidance of work coun-cils, which give workers power to affect the decisions that govern a spe-cific workplace.According to scholar Michel Albert,“all issues of concern

pri-to the workforce are referred pri-to these councils: training, redundancies,schedules, methods of payment, work patterns, etc.”29Moreover, lawrequires that large companies reserve one-half of their supervisoryboards for employee representatives.30This “codetermination” require-ment puts workers within the decision-making structure at the top of thefirm’s hierarchy.31This allocation of power and authority reflects the

German notion that “dialogue between partners is the indispensable oilthat keeps the wheels of business turning and reduces the likelihood ofdestructive social friction.”32The German model also has the uniquefeature of encouraging workers to feel appreciated and to take pride in thecorporation for which they labor because they have an appreciable voice

in its governance In short,“The company is seen by all its members as a

community of interests, a true partnership.”33This is unlike the Americanshareholder primacy model in which workers are valuable only as deper-sonalized, paid servants of the shareholders and managers Their interestsmatter only if satisfying them can be translated into corporate gain

Of course, from the standpoint of short-sighted shareholders andmyopic managers, codetermination and work councils are by definition

inefficient because workers should be working rather than debating

work-place governance So it comes as no surprise that those who support theshareholder primacy model criticize the codetermination model ongrounds of economic inefficiency Yet, from the perspective of the work-

ers, these councils make the company more efficient at furthering and

protecting the interests of workers (more about this in chapter 3) ments about efficiency thus turn on what the goal of the corporation is.Onecannot criticize codetermination or other worker-oriented corporate gov-ernance reforms on the basis of efficiency unless one takes for grantedthat the purpose of corporations is to serve shareholders rather than allstakeholders or society in general And that is the fundamental question

Argu-to be answered rather than the starting assumption.

Hansmann and Kraakman say that this labor-oriented model of porate governance “has steadily lost power as a normative ideal.” They saythat “the growing view” is that worker participation in corporate decisionmaking produces “inefficient decisions, paralysis, or weak boards” andthat these “costs” likely outweigh “any potential benefits that workerparticipation might bring.”Instead, workers must depend on contract law,

cor-“supplemented by appropriate labor market regulation,” to protect them,

as it is “evidently superior” to worker participation in resolving conflictsbetween the firm and its workers.34When weighing these claims that theworker-involvement model is obsolete, however, note that Germanyprovides for its workers much better than the United States does Of allgreat industrialized nations, Germany has the shortest working week andthe highest wages.35What’s more, the gap between the best-paid and thelowest-paid workers is not as wide as in other countries

When one boils down the assertion that shareholder primacy is better

for society, or for the economy, what is really said is that shareholder

supremacy is better for corporations Hansmann and Kraakman say thatwith the globalization of business, companies organized in different wayshave increasingly come into direct competition They assert that “it isnow widely thought”that firms following the model of shareholder suprem-acy “have the upper hand” in these competitions.36These “important com-petitive advantages” include, apparently, access to capital at lower cost,

“stronger incentives” to reorganize in ways that are “managerially ent,” and the ability to abandon “inefficient investments” more quickly.37

coher-This list of so-called competitive advantages, however, relates not tothe economy as a whole but to the ability of the corporation to maximizeshareholder advantage The structure of the argument is tautological:the shareholder-oriented model is superior because it is better at maxi-mizing shareholder welfare The abandonment of inefficient investments,for example, is simply another way of saying that the company can close aplant or lay off workers with less concern for the workers than for theprofit of the corporation Managerial coherence, I suppose, means theability of management to control the operation of the firm with littleconcern for the presumed inefficiency of worker involvement Access tocapital at lower cost is simply another way of saying that shareholders willappreciate being supreme, thank you very much

Hansmann and Kraakman’s argument thus shows only that holder-oriented firms will beat out other firms if the measuring stick forthe competition is shareholder advantage Their argument does notprove, however, any other basis on which shareholder-oriented firms aresuperior to other firms

share-Furthermore, the very claim that shareholder supremacy is good forcorporations is itself contestable Here I do not mean that the argument iscontestable in the mundane sense that if corporations act as good citizensthey will benefit their shareholders, and to benefit their shareholders theymust be mindful of whether their workers, customers, creditors, andcommunities are happy The argument is contestable in the far more fun-damental sense that serving shareholder interests may not actually maxi-mize the value of the firm,even in economic terms.Because of shareholders’limited liability and broadly diversified investment portfolios, they arelargely indifferent to the well-being of any given corporation in whichthey own stock Most shareholders these days do not even know all thecompanies whose stock they own Instead, what shareholders care about

is not the fortunes of any particular company but the overall return ontheir mutual fund, pension fund, or stock portfolio

In short, a vast majority of corporations are owned by shareholders

who do not care greatly about the firm First of all, shareholders often feel

no real connection to the firm, much less consider themselves “owners” inany meaningful sense Indeed, most people who hold stock in a company

in any given moment did not ever contribute money to the firm Theybought the stock from someone who bought the stock from someonewho bought the stock from someone who bought the stock from aninvestment banker who bought it from the company Further, even forthose shareholders who do care about the direction of a corporation, thevast majority of people who own stock in the United States do not own alarge enough number of shares in the company to make them feel liketheir concerns will be heard

Second, because most shareholders invest in a number of differentcompanies, they are either neutral toward a specific company’s risky deci-

sions or they may even prefer the company take financial risks Diversified

shareholders want the management of any particular company to makedecisions that maximize the expected value of the results, even if theresults also are highly variable They will prefer decisions that might have

a high payoff but risk bankruptcy over safer decisions that provide lowerreturns but have less risk of pushing the firm into liquidation.38

This brings us to a crucial insight In contrast to shareholders, workershave every incentive to make sure that the companies they work for sur-vive and thrive, since their own well-being is more closely tied to the com-

pany Consequently, workers’ interests may function as a better placeholder

for the best interests of the firm Since shareholders are largely indifferent

to the possibility of any single firm failing, managers who make decisionsaccording to what is good for the shareholders will bring about the failure

of their companies more often than managers who make decisions based

on what is good for a broader mix of stakeholders If one really cares what

is better for a specific firm, shareholders’ desires should not dominate, atleast if we define “what is better for the firm” to include survival

Finally, workers have continuing relationships with firms in ways mostshareholders do not As a result of this unique relationship, taking ac-count of workers’ interests can inure to the firm’s benefit in yet anotherway—by building “positive reciprocity.”This is simply a fancy term for thenotion that people largely respond to others in the way they are treated.There is almost no room for this effect to occur in the company’s rela-tionship with most shareholders, since the contribution of capital is usu-ally an isolated act performed by someone who bought stock from thefirm many years earlier On the other hand, research shows that workerscan and often do “give back” to the firm when they are treated well.39For

example, when workers believe they are treated fairly by their employers,they are more productive and obey firm rules at a much higher rate thanwhen they feel they are mistreated.40The employment relationship is not

a zero-sum game (more about this in chapter 7)

In the end, I believe that the best one can say to defend the traditionalmodel is that shareholder-oriented corporate law is better for sharehold-ers I do not challenge this tautology I do believe that it is quite difficult tosay that a shareholder-oriented model is better for social welfare, even ineconomic terms, simply because it is the best model for fulfilling theinvestment-backed expectations of a disinterested few I believe that thebest corporate model is one that gives due regard to the goal of realizingthe preferences of shareholders but also does not deify those preferences

at the expense of other stakeholders, the firm as a whole, or society in eral If what we care about are the concerns of all the corporation’s stake-holders, then a “stakeholder model” is likely to be more efficient inachieving that goal than a model that focuses on shareholders and man-agers only

gen-So then, how could we reorganize corporate law? We may have to goback to questions of the first order.What is clear, at the very least, is that if

we want to help workers, rather than shareholders alone, we shouldorganize corporate law very differently Or if we value stability, or equal-ity, or any number of other public principles, we should organize corpo-rate law very differently

Corporate law should be seen not as a narrow, private-law field for theacolytes of law and economics Rather, it should be debated as if it were apart of larger social and macroeconomic policy Perhaps the United States

is productive and affluent enough that we would want to “spend” a little inopportunity costs to “buy” stability and safety and social harmony, thusreducing the chances of another tragedy such as September 11 Instead ofusing corporate law—which produces the fabric of governance for ourmost important and powerful nongovernmental institutions—to accen-tuate the antagonisms in society, perhaps we would want to craft amethod of corporate governance that promotes harmony and partner-ship Later chapters take this possibility seriously

Although Michel Albert wrote about these possibilities over a decadeago, his comments are even more relevant today One passage in particu-lar is worth quoting at length:

As the world becomes a more and more uncertain place, immaterialfactors like trust and belonging are increasingly important It becomes