Margaret Blair & Lynn Stout A TEAM PRODUCTION THEORY OF CORPORATE LAW

 Explanation of public corporation ownership  Shareholders (principal) own corporation and hire officers (agents)  Goal of corporation is to increase shareholder wealth  Corporation law is used to reduce “agency costs” and maintain faithfulness of directors/officers (agents) to the principals  E. Fama, Agency Problems and the Theory of the Firm (1980)  Advocated the separation of ‘management’ and ‘risk bearing’ roles  Used insights provided by Alchian and Demsetz (1972) to establish agent and principal roles PRINCIPAL-AGENT MODEL

 Published in 1972 in AER  Armen A. Alchian (University of California, Los Angeles)  Harold Demsetz (University of California, Los Angeles)  What makes a team?  The use of several resource types  The product does not equal a sum of individual contributions  Not all resources used by the team belong to one person  Think about two people lifting a 100lb box  Does each person lift 50lbs?  Does one lift 75lb and the other 25lb? PRODUCTION, INFORMATION COSTS, AND ECONOMIC ORGANIZATION

 Shirking: A problem with the a team  Fixed by using a “Monitor”  Residual claimant  Observe input behavior  Central party common to all contracts  Ability to alter team membership  Ability to sell these rights (ownership)  When does a team become a firm?  When it is possible to increase production through a team  When it is economical to estimate marginal productivity via observation PRODUCTION, INFORMATION COSTS, AND ECONOMIC ORGANIZATION

 Blair and Stout (1999) refute application of Principal-Agent Model and corollary that corporations’ primary goal is to maximize shareholder wealth  Model applies to firms in general, but provides no special insights into public corporations  Team Production Approach  Where a productive activity requires the combined investment and coordinated effort of two or more individuals or groups  Issues occur in form of ex ante (agreement) shirking and ex post (agreement) opportunism A TEAM PRODUCTION THEORY OF CORPORATE LAW

 Issues occurring under Team Production Approach circumvented by corporate law as a “Mediating Hierarchy”  Formation of Public Corporation provides a hierarchy existing outside original production team  All team members “agree to give up control rights over the output from the enterprise and over their firm-specific inputs” (i.e. to a BoD)  No single team member is a “principal” having right of control  Solves three primary issues with Team Production Approach:  Convoluted information-gathering and decision-making  Shirking and opportunism via principal-agent contracts  Disputes between team members regarding allocation of duties and rewards A TEAM PRODUCTION THEORY OF CORPORATE LAW

 A public corporation is not simply a “bundle of assets” under common ownership, but rather a complex collection of agreements between team members working together for mutual gain: “A nexus of firm-specific investments.”  Control over assets and outputs are mutually given up in order to reduce shirking and rent-hoarding via implementation of an internal mediating hierarchy A TEAM PRODUCTION THEORY OF CORPORATE LAW

 Influences of Corporate Law and Culture  Directors motived to do well if they want to maintain their positions  Directors also motivated by desire to maintain reputations  Corporate law limits ability of directors to serve their own interests  Directors unable to appropriate corporate assets beyond established compensation  Assumption exists that if directors cannot serve their own interests, they will serve the interests of their firm (Is this a valid assumption?)  Corporate culture motivates directors to serve as fair trustees of firm  Serves role of benevolent/trusted mediator implied in all contract theory KEEPING DIRECTORS FAITHFUL

 May only be a “second-best” solution to relegation of asset and firm output control  Given certain constrains, a board of directors may offer substantial reduction in inefficiencies and rent loss  Mediating Hierarchy Theory expands on legal view of corporation as a “nexus of contracts” (explicit and implicit)  Highlights importance of team production dynamics within public firms  Establishes tools to understand political nature of a corporation  Explains role of BoD in determining firm focus on employees/shareholders MEDIATING HIERARCHY THEORY