The Economic Structure of Corporate Law
"The Economic Structure of Corporate Law," by Frank H. Easterbrook and Daniel R. Fischel (1991) , sets out a theory of corporate law that interprets a corporation as a hypothetical contract between shareholders and managers.
Reaction to the book has been polarized. It has drawn raves from those who share the broad free-market perspectives of the authors and brickbats from other corners.
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Origin of the Book
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"The Economic Structure of Corporate Law" first saw life as a series of provocative law review articles. Fischel and Easterbrook first set out their views on corporate law in a series of articles published in prominent law journals between 1981 and 1986.
They wrote an overview, as a contribution to a Columbia Law Review symposium on their work, in 1989.
The book was published as a whole by Harvard University Press in 1991.
The Thesis of the Book
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Easterbrook and Fischel advance the view that corporations should be seen as the result of a hypothetical contract rather than as creatures of the state.
"The normative thesis of the book," they write, "is that corporate law should contain the terms the people [managers and investors especially] would have negotiated, were the costs of negotiating at arm's length for every contingency sufficiently law. The positive thesis is that corporate law almost always conforms to this model."
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Limited Liability
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Easterbrook and Fischel acknowledge an argument often made by those who see corporations as creatures of the state.
Equity investors (stockholders) in a corporation have limited liability--they can't, except in rare circumstances, be held responsible for the tort or contractual liabilities the entity incurs.
Limited liability, the authors write, "seems to be the antithesis of contract, a privilege bestowed on investors. In exchange for this boon, many argue, corporations should be required to submit to regulation, or do favors for customers and workers and neighbors."
The Flaw in That Argument
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The flaw the authors see in that argument is that there is nothing unique about limited liability in the corporate context. Debt investors in sole proprietorships, for example, have the same limit on their liability as equity investors in corporations do. A bank that lends $100 to a sole proprietor or a partnership can lose that $100, but is not on the hook for more.
They find, then, that their emphasis on a corporation as a hypothetical contract between two sets of private parties is consistent with the fact of limited liability, properly described.
Endorsement of Takeovers
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Another important aspect of the Easterbrook-Fischel view of corporations was their acceptance of the activity of corporate-takeover entrepreneurs. In the 1980s, those who engaged in this practice were looked at with some suspicion as "raiders" and "greenmailers."
But by 2008, Kate Litvak, of the University of Texas Law School, wrote that their view on this has held up well, "even if many might not agree that takeover defenses should be limited as strictly as Easterbrook and Fischel proposed."
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References
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