Corporate Power in Civil Society

4. Contractarians and Balancers

Contractarians and Balancers Many legal scholars questioned the “realism” of contractarian approaches to corporations and law in the 1980s and many continue to do so today. But, then as now, most appreciate the great merit of contractarians ’ central point about corporate law’s mandatory rules. The new market for corporate control did demonstrate that it is no longer necessary for courts to enforce many statutes and norms once thought to be core doctrines. John Coffee Jr.’s major objection to contractarianism, therefore, is not that it yields methodical criticisms of existing corporate law. Rather, his objection is that contractarians fail to account adequately for the vulnerability of stakeholders’ positions in corporations. So rather than defending existing law directly, his point is more subtle: Some mandatory rules may remain valuable because the corporate judiciary may potentially use them to hold management and controlling shareholders to their “implicit bargains” with stakeholders, to “enduring relations ” that are not technically legal contracts.1 As Lyman Johnson puts it: “Easterbrook and Fischel conceive of the corporation as a nexus of bilateral contracts. Investors stand only in a contractual relationship with the ‘firm’ (read ‘managers’ . . .), not with employees, suppliers, customers, or creditors.”2 What contractarians fail most to appreciate, by this account, is that a corporate nexus freed from all mandatory rules may devolve “naturally” into patterns of governance in which stakeholders are abused, positional conflicts degenerate into trench warfare, and economic efficiency declines. We cannot simply assume that every corporate nexus will develop an equilibrium state of efficient contracting, as if guided by a hidden hand.3 And we certainly cannot assume that every corporate nexus will adequately protect most stakeholders most of the time. 4 83 I. Fiduciary Law and Stakeholders Until the early 1980s, the American corporate judiciary typically approached the corporation in precisely the way that Johnson and Coffee think is too narrow. From the 1920s through the 1970s, American state courts rarely protected stakeholders’ positional interests by (a) intervening into governance disputes on behalf of shareholders with standing and then (b) second-guessing business decisions that adversely affected stakeholders.4 Moreover, stakeholders themselves lack “standing” with the corporate judiciary . They cannot bring corporate governance disputes to court in their own positional interests. Thus, when courts intervene into governance disputes on stakeholders’ behalf, they always do so indirectly. We discuss these judicial actions later (Chapter 8).For now,we assert two points without elaborating them. First, courts protect stakeholders at times by holding management more explicitly to its fiduciary duty of loyalty to the corporate entity. Then they leave the details of stakeholder protection to management’s business judgment. Second, by holding management to this duty, courts emphasize management’s role as the corporate entity’s trustee and de-emphasize its role as shareholders’ agent. This counterbalances shareholders’influence over management at least somewhat because in corporate law doctrine fiduciary duties trump other legal obligations.5 With this shift in emphasis, however, the corporate judiciary still defers to management ’s business judgment; it does not try to second-guess it on stakeholders ’ behalf. It simply accepts at face value that as management endeavors to identify and advance the entity’s collective interests, consistent with its duty of loyalty, it will in one way or another likely take stakeholders’ positional interests into account. Before a market for corporate control emerged in late 1983, state courts often permitted corporate officers of target corporations to defend themselves against hostile tender offers on the fiduciary law ground of exhibiting loyalty to the corporate entity.As long as target boards did not act“solely or primarily” to entrench themselves or management teams and instead credibly claimed they were protecting stakeholders more generally, state courts let defenses against hostile bids stand—at shareholders’ expense.6 Thus, in the 1970s courts did not concern themselves directly with the immediate externalities stakeholders might suffer at the hands of a management team not yet exposed to a market for corporate control. Back then, courts also had no reason to identify the possible institutional externalities of changes in corporate governance. Top management was not 84 | Contractarians and Balancers yet being challenged by hostile bids, and corporate governance structures were hardly in flux. The corporate judiciary took only two steps in the 1970s in bearing its historical responsibility of seeing to it that corporate power remains broadly consistent with institutional design. First, courts enforced the public law statutes in their states...