July 15, 2010
The "Problem-Solution" Dance of Corporate Law
Holman Jenkins wrote an interesting piece in the Wall Street Journal yesterday about the inherent tension between the corporate shareholder wealth maximization norm and the systemic risks posed by too-big-to-fail banks. Here's how I might add this problem to my usual "problem-solution dance" introduction to my Corporations class:
- Problem: Private investors won't finance necessary but risky ventures for fear of incurring personal liability as partners.
- Solution: Separate ownership from control via the corporate form, thus providing the theoretical justification for limiting investor liability to the amount invested in the venture.
- Problem: Investors remain wary of investing because now they are confronted by the agency problem, which arises when there is a high degree of risk that the interests of the managers of assets will conflict with the interests of the owners.
- Solution: Impose fiduciary duties on managers (and regulate securities markets) to support investor confidence.
- Problem: Being successful in business requires taking risk. Imposing trust-like fiduciary duties on managers will stifle the risk-taking diversified investors desire.
- Solution: Insulate managers from liability for business decisions via doctrines like the business judgment rule and a narrow interpretation of securities laws.
- Problem: Even if the balance struck above is generally satisfactory (and this is what I tell my students we'll spend the majority of Corporations trying to figure out), some corporations, like private banks, may pose systemic risks that make our usual willingness to tolerate some percentage of business failures unacceptable.
- Solution: We're working on it.