Who should make decisions for a corporation? And how should decisions about who makes decisions be made? These fundamental governance questions motivate much of corporate law, as lawmakers seek to strike a sensible balance of power between managers, shareholders, creditors, suppliers, and other players in the corporate system. This tightrope is not easy to walk, however, and no one can design rules that will block faulty managers from abusing control over a firm’s activities. Likewise, laws cannot completely prevent a rogue investor from pursuing some actions that yield private spoils but impose greater collective harm on the corporation and other investors. Corporate law can and should try to minimize these frictions, but they must be understood as the inevitable purchase price for other benefits that come with the coordination of economic activity through a firm.
Between managers and shareholders, much of this struggle plays out in three key dimensions: the vote, the lawsuit, and the sale. Shareholders elect directors, who then appoint top managers, and most of the firm’s decision making occurs through this delegated power. But shareholders who are upset with the corporation’s leadership can expel the directors during the next election cycle. Alternatively, shareholders who are concerned with a specific action (or lack of action) can file a lawsuit alleging some harm, such as a breach of fiduciary duty or violation of securities law. And shareholders who do not want to bother with voting or suing might just sell their shares. The common feature of these strategies is that they involve an ex-post response to a perceived slight. Increasingly, however, shareholders and managers are emphasizing tactics that move from ex-post response to ex-ante planning. Instead of removing individual directors, for example, a shareholder group might try to eliminate staggered boards - such that investors will find it easier to replace the entire board if warranted. Instead of fighting shareholder lawsuits in multiple jurisdictions, a board might adopt a forum selection provision that corrals future litigation into one preferred location. By shaping key aspects of corporate governance, before a specific incident arises, both directors and shareholders aim to establish structural rules that are favorable to their causes.
Not surprisingly, these ex-ante governance tactics are raising new legal problems. Judges are increasingly being asked to determine whether a given corporate bylaw is permissible. The current state of play is fluid, but the influential Delaware courts seem to be taking a more permissive attitude, based in part on the parallels between contract law and the corporate relationship. By conceptualizing the corporation as a collection of negotiated agreements between the firm and individual shareholders, proponents of ex-ante governance defend unilateral bylaw initiatives as the permissible product of flexible private ordering. The full implications of shoehorning corporations into contract law are not entirely clear - indeed, it is not altogether obvious who the exact parties are to the “corporate contract” - even though lawmakers have been stating this as a self-evident truth for almost a century. Nevertheless, the loose (though still controversial) embrace of preauthorized one-sided modification in contract law provides some theoretical support for upholding unilateral tactics.
This Article advances two primary claims. First, corporate law should not outsource the resolution of ex-ante governance problems to generalized principles of contract law. Contract law has not done a particularly good job of addressing the latecomer term problem, and the concerns presented are acute in the corporate context. (Moreover, tighter doctrinal coupling of these two legal fields raises a host of unanswered, and seemingly tangential, questions.) Second, if corporate law is to confront this problem directly, then its algorithms for delineating tolerable bylaws will require far greater clarification in the coming years as novel governance strategies proliferate.
Citation
George S. Geis, Ex-Ante Corporate Governance, 41 Journal of Corporate Law 609–645 (2016).