The Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities.

• Author: Page, Antony
• Position: Book review

THE FAILURE OF CORPORATE LAW: FUNDAMENTAL FLAWS AND PROGRESSIVE POSSIBILITIES. By Kent Greenfield. Chicago: University of Chicago Press. 2006. Pp. ix, 288. $45.

INTRODUCTION

Successful corporations create extraordinary wealth. The longstanding question is how this wealth should be distributed. (1) The conventional answer has been shareholder primacy. (2) Most stakeholders, such as customers, suppliers, creditors, and employees, must negotiate their portion ex ante, but everything left over, the residual interest, belongs to the corporation's shareholders. (3) The job of the board of directors is thus to maximize the residual interest, thereby creating shareholder value. Nobel Laureate Milton Friedman was perhaps the leading proponent of the shareholder-primacy model of corporate governance, famously arguing that "[f]ew trends could so thoroughly undermine the very foundations of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible" (4) At least since the days of President Reagan, this laissez-faire approach has tended to prevail, not only among the educated elite (5) but also on the Supreme Court. (6)

The progressive answer is that wealth should be distributed fairly to all stakeholders, and that corporations have a social responsibility that goes beyond the mere maximization of shareholder wealth. (7) Whereas shareholder primacists seek to protect shareholders (or their residual interest) from other stakeholders, particularly greedy corporate management, stakeholder primacists seek to protect the nonshareholder stakeholders from the overreaching corporation. (8)

In The Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities, Professor Kent Greenfield (9) develops and extends the argument for a broader stakeholder approach. (10) In Greenfield's view, the problem is that public corporations are only public in a very limited sense--anyone with a brokerage account and money can buy shares--rather than public in the sense of having societal obligations or even facing close governmental oversight (pp. 1-2). Corporate law should thus be reconceived as public law and employed as a powerful regulatory tool. (11) Greenfield proposes reforms that he believes will increase contributions to social welfare. (12) His proposals include eliminating the profit-maximization norm, extending the scope of fiduciary duties to include stakeholders other than shareholders, and requiring boards of directors to include stakeholder representatives who will meaningfully contribute to corporate decision making. (13) Although he accepts that these changes would be "profound," he also believes that they "would not require seismic shifts in corporate law" (p. 242).

It is also worth emphasizing the substantial areas of agreement between Greenfield and those he criticizes. For example, Greenfield recognizes that freedom of contract, even to maximize wealth, is important (p. 17-18). But he believes that this freedom should be balanced against other concerns, at least since the rejection of the near-universally criticized Lochner v. New York. (14) Financial wealth, after all, is (hopefully) not the most important thing in people's lives, but rather a means to other ends (pp. 132-33).

Moreover, Greenfield does not want to tamper with those special characteristics of corporations--perpetual existence, limited liability, specialized management, and share transferability--that create such a powerful ability to generate financial wealth (p. 131). He also accepts that wealth creation, by itself, is enough to make a corporation successful, at least absent negative externalities (p. 132). He takes pains to note (perhaps a bit defensively?) that he does not advocate socialist economic organization and that, unlike some progressive corporate law supporters, he does not want to reduce corporations' First Amendment rights (pp. 241-42).

Reviewers have praised Greenfield's work effusively. Benedict Sheehy describes the book as a "seminal piece of writing" that "merits a place along Berle and Means, Easterbrook and Fischel, and indeed, one can but hope that it becomes the touchstone for further corporate law reform globally." (15) Joseph Singer writes that this is "simply the best and most well-reasoned progressive critique of corporate law yet written." (16) Laurence Boylan proclaims himself "moved" and "inspired" by this "persuasive" and "passionate book." (17)

Much of this praise is warranted. Greenfield is certainly passionate and almost always lucid. He is not, however, always persuasive.

Greenfield is perhaps weakest in explaining market failure. He argues that some of his proposals will increase corporate profits. If this is so, his explanations for why corporations do not already follow his suggestions are sometimes unsatisfactory. Mainstream publications have already recognized that corporate social responsibility will sometimes increase profits and is thus simply good management. (18) Even without a change in the legal regime, many corporations are already moving in Greenfield's direction: "[c]orporate social responsibility, once a do-gooding sideshow, is now seen as mainstream." (19) Why then are these legal changes necessary?

Greenfield's answer might be externalities. Corporations do not bear all the costs of their actions, leading to flawed decisions that might benefit them but that are harmful to society. Greenfield's overarching claim is that corporate law in the United States, by encouraging decision making based on incomplete costs and benefits, is inherently flawed, resulting in "corporate scandals ... artificially low wages for working people, environmental degradation, and an even higher risk of terrorist attacks" (p. 2).

Undoubtedly these are problems; perhaps of greatest interest are Greenfield's focus on corporate law as the solution (20) and his overall argument that corporate law matters. (21) For example, he boldly claims that "[c]orporate law made the tragedy of September 11 more possible, and thus made the war in Iraq more likely as well" (pp. 9-10). His proposed changes would result, he claims, in us not only being safer but also having more money, better jobs, a cleaner environment, more nutritious food, better products, stronger communities, an improved political process and reduced crime. (22)

Agreeing with Greenfield's goals, however, and viewing corporate law as the optimal vehicle of reform are two different things. (23) For example, problems with privatized airport security had many causes besides corporate law. (24) Or even if an antifraud law for workers is desirable, it does not follow that it should be a part of corporate rather than employment law. (25) Though Greenfield has highlighted its possible comparative advantages (pp. 181-83), corporate law is only one potential regulatory tool among many.

Part I of this Review discusses the modern "nexus of contracts" approach to corporations and highlights how Greenfield's views differ. Part II examines corporate goals and purposes, suggesting that Greenfield overstates the impact of the shareholder-primacy norm and does not offer a preferable alternative. Part III critiques the means to the ends---Greenfield's proposals for changing the mechanics of corporate governance. Although several of his proposals are intriguing, they seem unlikely to achieve their pro-social aims. This Review remains skeptical, in part because--even given its problems--the U.S. "director-centric governance structure has created the most successful economy the world has ever seen." (26) Overall, regardless of whether one is persuaded by all of his claims, Greenfield has made a valuable contribution to the field. Both lay readers and corporate law scholars of all types will find this an absorbing and thought-provoking book.

1. CORPORATE LAW: REGULATING A NEXUS OF CONTRACTS

   Greenfield accepts as his starting point the modern contractarian view that corporations are a legal fiction best seen as a "nexus of contracts," (27) rather than the concession-theory view that corporations are a creation of the state. (28) All corporate stakeholders--shareholders, creditors, employees, suppliers, customers, etc.--are assumed to have voluntarily entered into explicit or implicit "contracts" that define each party's rights and obligations. (29) Because participation is voluntary, parties will only enter into contracts that they think will make them better off, and parties are generally best suited to judge their own interests. Accordingly, state interference with private contracting should be relatively limited, at least where there is little impact on those who are not contractual parties. (30)

   The "nexus of contracts" theory views corporate law as a branch of private law (p. 29). Corporate law is predominantly enabling, existing merely to reduce transaction costs between shareholders and the directors who actually oversee the corporation. Rather than having the contracting parties invent or negotiate all contractual terms, the state essentially supplies a standard form contract comprised of the default rules that, as a general matter, the parties would have reached had they been able to negotiate them costlessly. (31) Parties are free to modify these default rules in case the state has provided suboptimal terms or they are simply unsuited to the situation. Contractarians view shareholders as having the most difficult relational contracts to negotiate. Therefore, corporate law includes hard-to-specify provisions like fiduciary duties in the shareholder contract, and "narrowly focuses on the rights and responsibilities contained within the 'contract' between management and shareholders," rather than addressing other stakeholders' contracts (p. 29).

   These other stakeholders must rely on something besides corporate law--such as expressly negotiated contracts, other government...