Theories of the Firm and Judicial Uncertainty

Publication year2012
CitationVol. 35 No. 04


Theories of the Firm and Judicial Uncertainty

Andrew S. Gold(fn*)

I. Introduction

There is no necessary connection between academics' theories of the firm and judicial theories of the firm. Economists and legal scholars may adopt one theory of the firm, and courts may adopt another. We might even predict this result. Judges are not economists, and as increasingly sophisticated theories of the firm emerge in the academic literature, judges are not well-positioned to keep pace with the evolving accounts. Indeed, judges may reasonably choose to adopt no theory at all.

Given these premises, this Essay explores the relationship between academically developed theories of the firm and corporate legal doctrine. Legal scholars who focus on theories of the firm often develop an interpretation of corporate law that endorses a particular legal theory of the firm. On these accounts, courts are thought to have adopted a commentator's preferred theory (consciously or otherwise), with legal doctrine seen as a means of facilitating the formation and governance of firms with the desired features. There is another interpretation of corporate law worth considering, however.

This Essay hypothesizes that much of corporate legal doctrine can be explained differently-not as the legal adoption of a particular theory of the firm, but rather as a response to judicial uncertainty regarding the correct theory of the firm. Theories of the firm still matter on this ac-count-they motivate judicial reasoning-but they are not specifically adopted by corporate law.

There is also evidence in support of this hypothesis. Courts, in fact, seem to go out of their way to avoid adopting a particular theory of the firm. At the same time, actual case outcomes are subject to multiple interpretations from a theory of the firm perspective. Moreover, leading explanatory theories often must identify at least some cases as exceptions to the rule, a necessity that indicates these theories do not perfectly fit the case law. These circumstances suggest the courts' expressions of indecision on theories of the firm may reflect an underlying reality.(fn1)

Notably, there are now a variety of theories of the firm relevant to corporate law. It is increasingly hard for legal institutions to adjudicate between these theories. This concern is compounded by the possibility that particular theories of the firm will fit best at different stages of a firm's life span. Given that Delaware courts generally adopt one corporate law for various different types of corporations (from closely held to public),(fn2) it is a challenge to determine how best to set the legal default. Even if courts could ascertain the best legal conception of the firm for purposes of public firms, this would not necessarily be the best legal conception of the firm for a corporate law that will regulate both public and private firms.

Corporate law, however, may take into account the variety of theories of the firm by choosing not to adopt any particular theory. In other words, judicial uncertainty may be a factor driving much of corporate law.(fn3) Courts may, quite understandably, wish to avoid standing in the way of whichever theory is best, while not knowing which theory that will be. We may then explain important features of corporate law in terms of their indeterminacy on theories of the firm.

Given these possibilities, the discussion below will suggest a reading of corporate law that does not take sides on theory of the firm debates. In order to keep the analysis concise, this discussion will focus on fiduciary duties and doctrines related to their enforcement. Part II of this Essay will suggest an indeterminacy of corporate law with respect to theories of the firm, in light of express judicial statements on the topic. Part III will assess the significance of the business judgment rule. Part IV will assess the legal ambiguity concerning the identity of directors' fiduciary beneficiaries. Part V will assess corporate purpose clauses. Part VI then concludes.

II. Express Statements Suggesting Legal Indeterminacy

This Essay introduces a hypothesis that much of corporate law can be explained in terms of a choice not to adopt a particular theory of the firm, rather than an application of a particular theory of the firm. Because this proposed explanation requires us to interpret corporate law, a brief note on methodology may be helpful at the outset.

A. Explanatory Methodology

Interpretive legal theories do not always state their criteria for a successful interpretation. When they do so, such theories often emphasize the fit between a legal theory and legal doctrine, and they often emphasize the normative justification for having a legal doctrine that matches the preferred interpretation.(fn4) Other criteria, however, may also matter. For example, some theorists are concerned with predictive suc-cess,(fn5) and some are concerned with the transparency of judicial reasoning (that is, they are concerned with adopting explanations that assume courts mean what they say).(fn6) Coherence is also an important aim.(fn7)

That said, fit and justification are especially salient, particularly among scholars concerned with theories of the firm. Commonly, legal scholars' accounts of corporate law combine a normative analysis that explains why a particular theory of the firm is desirable for corporate law to adopt with a positive account that explains how this theory of the firm is largely consistent with existing corporate law precedents.(fn8) While the criteria for a successful interpretation are often left unsaid, descriptive fit and normative justification appear to dominate these explanatory accounts.

The difficulty for present purposes is that each of the leading theories has a plausible claim to meet a reasonable fit criterion, and the outcome under the justification criterion is a matter of dispute. Proponents of each leading theory can point to cases that seem to recognize their chosen theory of the firm. In addition, proponents of each leading theory can argue that the true basis for the desirability of the firm is the benefit that they discern.

With respect to the fit criterion, it is hard to find clear winners among the contending factions. Once we include the law as it relates to both public and private corporations, the law as it relates to takeovers, and the law as it relates to corporate philanthropy, we find that most theories have their strong and weak spots. We might conclude that certain explanatory failures should be fatal to an interpretation. But as a general matter, it is a difficult problem for an interpretive legal theory to explain precisely how stringent the fit criterion should be.(fn9) Absent a compelling account for treating some cases as peripheral and other cases as core, it is difficult to differentiate among the leading theories purely on the basis of doctrinal fit.

With respect to normative criteria, efficiency goals are largely shared by the leading explanatory accounts. Determining which account best squares with an efficiency aim is substantially more challenging. The empirical question whether a particular theory of the firm best comports with efficiency goals is hard to assess. More to the point, it presents an empirical problem that courts are poorly suited to resolve. Courts are often considered to have weaknesses when it comes to determining the best means to an end for individual firms. But these weaknesses are not limited to ordinary business decisions. If we think courts cannot readily determine the best business choices for individual firms, why should we think they can readily determine the best theory of the firm?

These concerns can help motivate a different type of explanatory theory. Suppose we try to interpret corporate law as a legal domain designed with theories of the firm in mind but without any particular theory of the firm. Would this interpretation fit the legal doctrine? Would it also be justifiable to have a legal doctrine with such features? The sections below will suggest, at least in part, what such an interpretation might look like.(fn10)

B. Evidence of Indeterminacy in Legal Reasoning

As a starting point, one place we might look to see whether courts have affirmatively adopted a theory of the firm is the express language of judicial opinions.(fn11) There is no question that theories of the firm have influenced judicial decision-making. Particularly in Delaware, the bench is staffed with judges who read and respond to developments in economic and legal scholarship. But as we will see, the evidence that they have adopted a particular theory is equivocal.

It is uncommon for Delaware courts to affirmatively mention the "theory of the firm." (A Westlaw search for this phrase in Delaware cases turns up few examples.) Courts clearly respond to the theory of the firm literature, however. Indeed, Chancellor Allen specifically discusses theories of the firm in the reasoning of a judicial opinion. What is striking, to the extent express discussions exist, is the judicial ambivalence that these cases suggest.

For example, in Stahl v. Apple Bancorp, Inc., Chancellor Allen notes that "the prospect of losing a validly conducted shareholder vote cannot, in my opinion, constitute a legitimate threat to a corporate interest, at least if one accepts the traditional model...

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