The Corporate Contract in Changing Times: Is the Law Keeping Up?

by Steven Davidoff Solomon (Editor), Randall Stuart Thomas (Editor)

Overview

Over the past few decades, significant changes have occurred across capital markets. Shareholder activists have become more prominent, institutional investors have begun to wield more power, and intermediaries like investment advisory firms have greatly increased their influence. These changes to the economic environment in which corporations operate have outpaced changes in basic corporate law and left corporations uncertain of how to respond to the new dynamics and adhere to their fiduciary duties to stockholders.
           
With The Corporate Contract in Changing Times, Steven Davidoff Solomon and Randall Stuart Thomas bring together leading corporate law scholars, judges, and lawyers from top corporate law firms to explore what needs to change and what has prevented reform thus far. Among the topics addressed are how the law could be adapted to the reality that activist hedge funds pose a more serious threat to corporations than the hostile takeovers and how statutory laws, such as the rules governing appraisal rights, could be reviewed in the wake of appraisal arbitrage. Together, the contributors surface promising paths forward for future corporate law and public policy.
 

Product Details

ISBN-13:	9780226599540
Publisher:	University of Chicago Press
Publication date:	03/08/2019
Sold by:	Barnes & Noble
Format:	eBook
Pages:	336
File size:	558 KB

About the Author

Steven Davidoff Solomon is professor at the University of California, Berkeley, School of Law, where he is also faculty director of the Berkeley Center for Law and Business. He is a former weekly columnist for the New York Times DealBook. Randall Stuart Thomas is the John S. Beasley II Chair in Law and Business and director of the Law and Business Program at Vanderbilt Law School.

Read an Excerpt

CHAPTER 1

Why New Corporate Law Arises

Implications for the Twenty-First Century

Robert B. Thompson

Corporate law is facing calls for change that are more intense than those heard in decades. Shareholders are more aggressively pushing back against management. In turn, other corporate stakeholders are expressing increasing concern about shareholders' use of their power for selfish reasons and the perceived pernicious impact of shareholder wealth maximization as a guide for corporate law. Why does corporate law change, and how it might change now?

Corporate law changed regularly in the first half of our country's history. A series of innovations followed one after another during the nineteenth century, including limited liability, general incorporation statutes, a strong shift to director-centric corporate governance, authorization of corporations holding stock in other corporations, and the disappearance of ultra vires and other limits on corporate behavior. By the arrival of the twentieth century, all the key economic elements of the modern corporation were in view, and corporate law settled into a stable pattern we still see today. State law abandoned its prior regulatory approach and its continual change in favor of a director-centric structure with expansive room for private ordering that has remained remarkably stable. Federal law stepped in to restrain economic concentration (antitrust law), to protect employees and consumers against corporate power (done by industry regulation and employment and consumer laws, not corporate governance), to limit corporate political contributions, and to make recurring, if sporadic and noncomprehensive, efforts to enhance the role of shareholders against managers.

This chapter examines this history of change in corporate law in America, the dramatic and abrupt shift in the focus of state corporate law visible in the last decade of the nineteenth century, the interactive pattern of state and federal law that has grown up over the second half of the country's history, and prominent theories explaining what leads to corporate law change. Together these various strands suggest there will be no fundamental change in corporate law even in this time of visible stress to the now classic structure.

Prior Changes in Corporate Law

Over the first decades of the nineteenth century, for-profit corporations came to supplant religious, charitable, and quasi-public (bridge or turnpike) entities as principal users of the corporate form (Blumberg 1990). Corporate law changes reflected and facilitated this trend. By the end of the century, the modern corporation was in view with the economic characteristics that are familiar to twenty-first-century lawyers and business people. The 1890s presented a key inflection point for corporate law. States abandoned their regulatory approach to corporations in favor of permissive laws that were director-centric in their allocation of power and left ample room for market decision making, contracting, and private ordering. The government's regulatory impulse did not disappear, however, but came to be expressed in various regulatory regimes in federal law — for example, antitrust, worker protection, and the parts of federal securities laws that addressed corporate governance.

Changes over the Nineteenth Century

Corporations evolved dramatically over the nineteenth century in America, accompanied by recurring changes in corporate law. The legal changes occurred incrementally among the various states over multiple decades, often with each change occurring in partial steps in an individual state, making the national change seem even more incremental. The statutory changes in turn reflected fundamental economic and financial changes that were taking place on the ground that continued to evolve. By the end of the century, these various trends had jelled into a legal form we would recognize as the modern corporation and a regulatory structure that would be familiar to modern corporate lawyers. The components of this dramatic transformation of the corporation and its regulatory structure included: (1) growth in the number of corporations and the increasing dominance of for-profit entities; (2) limited liability for shareholders becoming the usual rule; (3) the move from special legislative chartering of each corporation to general incorporation laws; (4) evolution in the corporate form to facilitate centralized management and the rise of middle management in business to take greater advantage of this corporate characteristic; (5) public trading of stocks; and (6) permitting corporations to own stock in other corporations.

Growth in the Number of Incorporations and the Increasing Dominance of For-Profit Entities. Joseph Ellis (2015) has described the move to the Constitution from the Declaration of Independence (and the weak Articles of Confederation that connected the newly independent states) as a second American revolution that turned on a change in the size of the world that Americans defined for themselves. In the colonial period, the geographic space citizens considered relevant for their political and business life was small, perhaps thirty miles; giving powers to a national government seemed too likely to reprise the oppression of the British crown against which the revolution had been fought. But the dysfunction of the confederation government, and perhaps some sense of the economic possibilities in a larger republic, led to a change in the form of government, which facilitated a broadened geographic frame of reference for politics that would soon be followed in American business. Over time there was opportunity, and a greater need, for enterprises that assembled the capital from more than one person (Livermore 1939), and over time improvements in transportation and machinery increased the size of the market in which entrepreneurs could compete effectively. The result was a dramatic increase in the number of corporations, particularly for-profit corporations, in the early nineteenth century.

Some of the most visible early nineteenth-century corporations were created for bridge or turnpike companies; these infrastructure projects were needed by the community but were financed with private funds under a governmental charter, leading to a close association in the minds of the public between specially chartered corporations and worries about privilege and monopoly. Banking corporations were common and the subject of much of the Supreme Court litigation of the period (Blair and Pollman 2015), raising questions of how to regulate entities affecting the money supply and similar issues that invoked core public issues. By the 1830s, manufacturing corporations exceeded those in banking, insurance, and public service and the number was growing (Blumberg 1990); more companies were incorporated in Illinois in the 1850s than in the entire first half of the century (Dodd 1936).

Limited Liability. As the size of markets and the need for capital in a particular business grew, limited liability was seen as a way to encourage entrepreneurial risk taking. Several states adopted such rules in the first two decades of the nineteenth century. Massachusetts moved to limited liability for shareholders in 1830, and this rule became common in other states for corporations. Even so, it did not provide complete insulation from limited liability. Double liability, subjecting shareholders to personal liability for corporate obligations beyond their original investment up to an additional sum equal to that amount, remained the norm for the remainder of the century (and continued for California corporations and for national banks into the middle of the twentieth century) (Horwitz 1986).

General Incorporation Statutes. Concerns about privileges provided to incorporated businesses at the expense of the larger population, mixed in with Jacksonian opposition to rechartering the Bank of the United States (banks generally being one of the most visible groups of incorporated entities), led to passage of general incorporation statutes in some states in the 1830s and 1840s and in almost all states by 1875 (Hamil 1999). This may be the largest single statutory change for corporate law over the nineteenth century, but consistent with the other changes, it happened incrementally — four states in the 1830s, three in the 1850s, and continuing to build (Hilt 2008). Even as the states moved to provide general incorporation, many of them did not prohibit state legislatures from continuing to provide special charters to individual companies on whatever terms the legislature desired. Delaware, for example, had a general incorporation statute as early as 1875 (and relaxed the conditions for the use of the general statute in 1883); even so, in 1897, just before Delaware's modern statute of 1899, the number of special charters (115) was more than eleven times greater than the ten entities that used the general incorporation law for that same year (Arsht 1976).

Eric Hilt traced the impact of Massachusetts's general corporation act of 1851, under which the state continued to retain special chartering from the legislature after enacting a general incorporation statute. Hilt found that "the firms created under the general act looked quite different" from firms chartered prior to 1851 (when special chartering was the only option) or firms that used the special charter route after 1851 (Hilt 2008, at 25). They were more diffuse in their industries and geography than the specially chartered firms, were significantly smaller with fewer shareholders, and had much higher degrees of managerial ownership (Hilt 2008).

Centralized Management. Centralized management has long been an advantage of the corporate form, but its use in business corporations changed dramatically in the nineteenth century, for both legal and economic reasons. Educational and other charitable and nonprofit corporations had previously received charters that put control in a board of trustees or directors. Livermore's treatment of land companies on the western frontier before and after the Revolutionary War shows some degree of centralized governance in these business firms even without charters in a setting where citizens were making "side" investments to their everyday commercial pursuits (Livermore 1939).

General use of centralized management was later in coming than the two characteristics of limited liability and general incorporation just described. New Deal Supreme Court Justice Wiley Rutledge, in his earlier role as a corporations law professor, observed that "the general incorporation laws of the nineteenth century were designed primarily to extend the privilege of limited liability to what may be termed 'incorporated partnerships' and relatively local joint stock companies rather than the creation of institutions national in the spread of their securities and activities" (Rutledge 1937 at 307). Noted business historian Alfred Chandler similarly described the increasing use of the incorporated stock company in the early nineteenth century, but through the 1840s he saw no change in the relatively decentralized governance characteristics that still proved satisfactory for most businesses (Chandler 1977).

Over the latter half of the nineteenth century, there was a gradual decline in the importance of the general meeting of shareholders as reflected in the broadening power exercised by directors. Dodd (1936) noted, for example, the very broad powers given directors in general incorporation acts such as that of Illinois in 1872. Horwitz (1986 at 182) identified this late nineteenth-century shifting of power away from shareholders to directors so that after 1900 directors were treated "as equivalent to the corporation itself."

The legal changes reflected the evolution in market and financial conditions after the Civil War, when innovations propelled by the Industrial Revolution and changes in transportation, manufacturing, and distribution increased the scope of markets in which firms could compete. Middle management that had not earlier existed became a common feature of corporations, and managers who did not own a majority of shares acquired effective control of many firms. Depending on how businesses became large in this new environment, some firms whose internal growth was sufficient to meet their capital needs became managerial under the control of the founders or family. By contrast, firms that needed outside capital to become large and take advantage of the new economies of scale were run by managers with only a minority of stock ownership (Chandler 1977). Once statutes provided for control by directors, as set out in the early Delaware general incorporation statutes described below, and provided for director appointment of other officers and agents, the statutory structure was sufficiently malleable to permit the growth of top executives and middle managers as economic conditions evolved.

Public Trading of Stocks. Like the centralized control just described, public trading of stock reflected the changing possibilities provided by evolving markets and finance. Early general corporation statutes proclaimed stock to be personal property and provided for its sale by means set forth in the bylaws (Hilt 2015 at 9). After the Civil War, stock exchanges expanded to include a larger number of manufacturing firms that effectively provided free transferability across a broad range of America's largest firms without the need for any bylaw provision or private contracting (Navin and Sears 1955 at 107–8). By the end of the nineteenth century, free transferability had developed to the point where it became a usual characteristic of the modern conception of a corporation.

Recognition of Holding Companies. The last characteristic of the modern corporation to appear in the nineteenth century was the statutory grant to corporations to own stock in other corporations. Changes in economic and financial conditions showed the benefit of controlling entities operating in multiple states. Yet doing business outside the state of incorporation presented some difficulty for corporations given a Supreme Court decision in 1839 that declined to find such a constitutional right for corporations. Entrepreneurs such as John D. Rockefeller looked to trusts as a way to structure the burgeoning oil refinery business that he was assembling. He organized the South Improvement Company in the 1870s and then made Standard Oil into a trust in the 1880s, providing the same centralized control available within the corporate form but without the limits in operating across state lines or owning stock in other corporations (Chandler 1977 at 323). When state courts in Louisiana, New York, and Ohio found trusts in cotton, sugar, and oil violated state corporations laws, New Jersey came to their rescue. In 1888 and 1889, amendments to the New Jersey corporations statute authorized corporations to own stock in other corporations (Horwitz 1986 at 195).

The Modern Corporation in View: The Inflection Point in the Late Nineteenth Century That Shaped Corporate Law

By the late 1880s, all the elements of the modern corporation were in view (if not yet spread to all corners of the country). It was a coming together of the expansion in the geographic and industrial scale that could be supported in the growing American economy and the administrative ascendancy of middle managers (Chandler 1977). Corporate law reflected and facilitated these changes; the liberalizations of New Jersey's general incorporation act of 1896 provided no limit on a corporation's duration, permitted incorporation for any lawful purpose and to carry on business in other jurisdictions, authorized mergers and consolidations, and enabled director amendments of bylaws (Strine and Walter 2015). New Jersey became the home not just of Standard Oil but of a substantial percentage of larger New York businesses. The race among the states was on, with New Jersey being the early favorite and Delaware stepping into New Jersey's shoes after that state's governor, Woodrow Wilson, pushed reform on his way to Washington to assume the presidency (Yablon 2007). This period also saw a decline in other traditional restrictions on corporations — the disappearance of ultra vires and quo warranto actions that had been used to limit corporations' acts — and a similar shriveling of state efforts to assert control over foreign corporations (Horwitz 1986).

Here we see a wholesale state law abandonment of the prior regulatory approach to corporations in favor of the permissive directorcentric approach with more room for private ordering that still characterizes American corporate law. Joel Seligman (1976) termed it a "revolution wrought in the law of corporations" (264) that led to general incorporation statutes that "turned corporate law inside out" (273). Similarly, Justice (then Professor) Rutledge described the New Jersey law of 1887–1891 as "destined eventually to reverse the historic policy of the states [and] to place state policy fundamentally in opposition to that of the Federal government" (Rutledge 1937 at 311–12).

(Continues…)

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Table of Contents

Foreword Leo E. Strine Jr.
Introduction

Chapter 1. Why New Corporate Law Arises: Implications for the Twenty-First Century Robert B. Thompson
Chapter 2. The Rise and Fall of Delaware’s Takeover Standards Steven Davidoff Solomon and Randall S. Thomas
Chapter 3. In Search of Lost Time: What If Delaware Had Not Adopted Shareholder Primacy? David J. Berger
Chapter 4. The Odd Couple: Delaware and Public Benefit Corporations Michael B. Dorff
Chapter 5. Delaware’s Diminishment? Hillary A. Sale
Chapter 6. Delaware and Financial Risk Frank Partnoy
Chapter 7. Hedge Fund Activism, Poison Pills, and the Jurisprudence of Threat William W. Bratton
Chapter 8. Corporate Governance beyond Economics Elizabeth Pollman
Chapter 9. The Many Modern Sources of Business Law Colleen Honigsberg and Robert J. Jackson Jr.
Chapter 10. Appraisal after Dell Guhan Subramanian
Chapter 11. Boilermakers and the Contractual Approach to Litigation Bylaws Jill E. Fisch
Chapter 12. Litigation Rights and the Corporate Contract Verity Winship
Chapter 13. Private Ordering Post-Trulia: Why No-Pay Provisions Can Fix the Deal Tax and Forum Selection Provisions Can’t Sean J. Griffith
Chapter 14. International Compliance Regimes Stavros Gadinis
List of Contributors
Index