Can Culture Constrain the Economic Model of
Corporate Law?
Mark J. Roe
Summer 2002
Final version, with differing pagination, later published at 69 University of Chicago
Law Review 1251 (2002).
Available at http://ssrn.com/abstract=320882
Can Culture Constrain the Economic Model of
Corporate Law?
Mark J. Roe*
With a few simple “moves,” we can see where the economic model of
corporate law could bump up against cultural limits. Or, better put, the
economic model works well in the United States because little until now
impedes Coasian re-bargaining among shareholders and managers.
Begin with the economic model without limit: Takeovers persisted in the
face of anti-takeover law in the 1990s, one can argue, because many
managers were paid to stop from strongly opposing most takeovers. But
managers’ pay cannot be varied everywhere in the world as easily as it
was raised in the Untied States. (The recent scandals show how wide
that latitude has been here.). Where it cannot be so easily varied, re-
splitting the corporate pie in managers’ favor is harder. More
generally, culture could affect the economic model if it affects the
relative cost of institutional substitutes, by, say, degrading one form of
organization but not others. Basic structures of corporate law—indeed,
one could imagine even the public firm with diffuse ownership—could be
affected by the degree to which local culture allows parties to vary their
deals smoothly. When local norms make key variations costly,
boundaries to the economic model of a type seldom thus far confining
the American corporation appear. I sketch out, with the help of a
Symposium’s papers, where those boundaries can be glimpsed.
__________________________________________________________________
* David Berg Professor of Law, Harvard Law School.
Can Culture Constrain the Economic Model of
Corporate Law?
Mark J. Roe†
TABLE OF CONTENTS
Introduction......................................................................................1251
I. The Economic Model without Limit.....................................….1254
A. Antitakeover Law Pressure on the Three-Party Bargain…1254
B. The Coasean Bargain Redone.............................................1254
II. Cultural Limits to the Economic Model?...................................1256
A. As Affecting the Quality of Institutional Substitutes.....….1257
B. As Degrading the Organization...........................................1258
C. As Reconfiguring a Persisting Economic Model............…1259
D. As Distant in the United States, and Closer-in Abroad.…..1260
III. Can Culture Ever Affect CorporateLaw and Interested Party
Transactions?…………………………………………..…..…1262
IV. Cultural Endogeneity: How Economics Constrains Culture.…1264
V. Political and Social Limits?……………………………...…....1265
Conclusion: Glimpses of Boundaries to the Economic Model of the
Corporation...........................................................................….1268
INTRODUCTION
Are there boundaries to the economic model of the structure of
corporate law? If so, where do they begin? Much scholarship in this
Symposium deepens the model of corporate law as a three-player con-
tract among shareholders, managers, and the board. It is a model that
Frank Easterbrook and Daniel Fischel used ten years ago here at The
University of Chicago Law School in their book, The Economic Struc-
ture of Corporate Law, which culminated and accumulated their work
on the contractarian model of the corporate law.1 Corporate law is—or
in its normative version should be—a contractarian arrangement be-
tween and among managers, the board, and shareholders. Corporate
law should be a set of default rules among these players, as the most
likely rules the players would adopt, or as the rules that would be the
easiest to contract away from (if the parties did not want them). Fidu-
___________________________________________________
† David Berg Professor of Law, Harvard Law School.
1 Frank H. Easterbrook and Daniel R. Fischel, The Economic Structure of Corporate Law
(Harvard 1991).
1251
1256 The University of Chicago Law Review [69:1255
ciary duties in this model represent the ex ante contract that managers
and shareholders would have reached. Corporate law and corporate
law judges referee, in this view, that three-player game. Corporate
structure results from players adapting their corporate institutions and
decisionmaking to the economic task at hand.
2
In its positive form, the contractarian perspective saw Delaware
as coming close to the economic model, with most of Delaware corpo-
rate law (except probably for takeover barriers) conforming to the
model. The Symposium articles fit this tradition. So the existence of
barriers to takeover tell some that the resulting increase in managerial
agency costs would drive up managerial compensation,
3
while it tells
others that the higher agency costs increase the demand for other
tools (such as more incentive-based compensation and more board
independence), tools that would constrain these higher agency costs.
4
Or it could tell others that the economic model could be better ap-
plied if the board had less authority to decide on a takeover and
shareholders had more.
5
Or it could tell others that the three-player
contract might be readjusted by giving the board yet more authority—
via three-year terms—subject to a “campaign financing” law that
would have the company pay the expenses for (some) shareholder-
initiated proxy fights: more security for managers in the short run,
with lowered costs to shareholders who challenge managers in the
medium run.
6
These views let us know that there is more to be said—and de-
bated—on how best to implement the economic model of corporate
law, a model that focuses on the three-player game of allocating deci-
sionmaking authority among managers, the board, and shareholders. It
is the model that has dominated corporate law scholarship and that
continues to dominate it. And it is a good model for us in the United
2 The corporation is, in this view, a more complicated contract, one that contracts with
suppliers, employees, and so on; but corporate law focuses on the three-player contract. Here I
show how culture could affect that three-party contract. American culture does not constrain it,
but it is imaginable that culture could—and probably other cultures do.
3 See Lucian Arye Bebchuk, Jesse M. Fried, and David I. Walker, Executive Compensation
in America: Optimal Contracting or Extraction of Rents?, 69 U Chi L Rev 751 (2002).
4 See Marcel Kahan and Edward B. Rock, How I Learned to Stop Worrying and Love the
Pill: Adaptive Responses to Takeover Law, 69 U Chi L Rev 873 (2002).
5 See Lucian Bebchuk, The Case Against Board Veto in Corporate Takeovers, 69 U Chi L
Rev 975 (2002). Similarly, Victor Brudney and Allen Ferrell would apply an economic model to
reallocate the power to make charitable gifts from managers to shareholders. See Victor Brud-
ney and Allen Ferrell, Corporate Charitable Giving, 69 U Chi L Rev 1995 (2002). And Fischel ar-
gues that the judges should resolve corporate disputes by using stock market prices, sometimes
reconstructed, whenever possible. Daniel Fischel, Market Evidence in Corporate Law, 69 U Chi L
Rev 943 (2002).
6 See William T. Allen, Jack B. Jacobs, and Leo E. Strine, Jr., The Great Takeover Debate: A
Meditation on Bridging the Conceptual Divide, 69 U Chi L Rev 1069 (2002).
2002] Cultural Constraints 1257
States because the constraints that the articles impose on the model
are attenuated, weak, and unimportant here.
But to see why the model works so well, we should look for its
boundaries; and the Symposium articles show us where we should be
exploring if we wanted to find those boundaries. That is, can we trace
the lines in the articles to discern the boundaries of that contractarian
model? Is there a limit, where other factors outside of the three-player
contractarian model kick in, factors that we would have to understand
if we were to explain the corporation well?
There is such a limit, and if we look at the bigger picture that the
Articles sketch out, we can catch glimmers of how culture could limit
the economic model. So here, I use the articles from this Symposium
to sketch out an outer limit, a boundary, to the economic model, where
that model starts to do less well as a positive matter in explaining what
institutions we see and which ones are effective (and where those of
us who think as a normative matter that the economic model in the
end usually best maximizes welfare might seek to roll back these lim-
its even farther).
In Part I of these Remarks, I trace out the economic model of how
takeovers, if impeded, should induce substitute institutions that keep
the corporate pie from diminishing too much in size, but that divide up
that corporate pie differently. In Part II, I sketch out how culture, such
as attitudes toward wealth, can facilitate or retard that Coasean re-
structuring; almost automatic in the United States, that new division of
the pie still would encounter resistance elsewhere. Culture can vary the
costliness of substitutes in the economic model. And by varying costs,
culture can vary the efficacy of the substitutes. Culture could limit this
Coasean restructuring, but in the United States, it does not.
In Part III, I expand this notion of cultural boundaries: even basic
corporate law characteristics, such the efficacy of controls on inter-
ested party transactions, could be a function not just of finance, eco-
nomic rationality, and institutional capacity, but also of cultural back-
ground. Identical institutions could produce widely varying results if
we vary just one cultural consideration: varying attitudes toward
wealth can vastly vary the efficacy of these institutions, the ease of
ownership separation, and whether the Berle-Means firm will domi-
nate an economy or be a minor, secondary business institution.
In Part IV, I look at the interaction between culture and econom-
ics, how and when economics dominates culture, and how and when
each is independent. In Part V, I trace out two political limits to the
economic model—one known and revealed in the Symposium—of
how legislative politics and judicial sympathies can cap and limit the
economic model.
1258 The University of Chicago Law Review [69:1255
I. THE ECONOMIC MODEL WITHOUT LIMIT
A. Antitakeover Law Pressure on the Three-Party Bargain
Let us start with the perspective that takeovers reduce manage-
rial agency costs to shareholders. It is the usual perspective but not a
unanimous one. But let us pass on that debate here. And let us posit
that we operate in the “space” where product, capital, and labor mar-
ket competition do not fully constrain the managers to work for share-
holders. (No need to sketch out limits to these markets: We all know
those limits exist, although opinions differ as to where the line is.) In
that “space,” we posit, takeovers make managers work for sharehold-
ers.
But then antitakeover structures (such as poison pills), legislation,
and court decisions (which the legislature does not overturn) impede
takeovers. (One limit to an economic model might be right here. Why
do courts constrain takeovers, and why do legislatures let those deci-
sions stand or add to the barriers?
7
Three-party efficiency might be an
answer. But the shape of the corporation is partly determined by why
the polity validates antitakeover mechanisms, such as the pill. It is not
economically foreordained
8
—more on that below.)
So antitakeover structures make managers less loyal to share-
holders. Managerial agency costs rise, so the demand for takeovers
persists and, indeed, increases. If managerial agency costs rise, players
would then pay “more” for takeovers.
B. The Coasean Bargain Redone
In Marcel Kahan and Edward Rock’s model, with the gates open
for high compensation, we see an institution that “buys” managers off
from opposing takeovers. True, managers can now “just say no” (most
7 Compare Moran v Household International, Inc, 500 A2d 1346 (Del 1985) (holding that
the directors’ poison pill defense was within the business judgment rule), with Smith v Van
Gorkom, 488 A2d 858 (Del 1985) (holding that the business judgment rule did not protect deci-
sions by directors who were not reasonably informed). The former validated the poison pill and
was upheld. The latter lambasted directors and was effectively repealed. See 8 Del Code Ann
§ 102(b)(7) (1991 & Supp 1993) (permitting corporations to eliminate personal liability of direc-
tors for breach of fiduciary duty).
8 So it is logically possible that Bebchuk, 69 U Chi L Rev 975 (cited in note 5) (arguing
that it is preferable to give boards less veto power over takeovers), sketches out the appropriate
economic model but that politics trumps it. Or, via Coase, there are several possible models, and
the political muscle of managers determines which one of the plausible models wins out. Indeed,
this might constitute one of the boundaries to economic analysis: the political muscle of manag-
ers has implications here. And managers may win if they have political allies. Is the result wealth-
maximizing or do managers win because they “have the votes”? One answer is that legislatures
listen to managers, especially when the bystanders (employees, consumers, average citizens) are
wary of hostile takeovers. Let us put this potential limit aside for now, although it potentially
cabins the pure economic model.
2002] Cultural Constraints 1259
of the time). But money can change their minds. It would be awk-
ward—and visibly in violation of corporate law duties—if the offering
company directly presented managers a check for $20 million on con-
dition that those managers drop their opposition to a hostile bid and
managers cashed that check. But if there are preexisting options in
place with a value of $20 million if the takeover vests, then the man-
agers see the personal value to them of the bid going forward. And
then they often acquiesce.
The economic model, in a first cut at the issue, is vindicated.
Managers have a “property” right to resist takeovers, but in a Coasean
bargain—indirect, to be sure, and perhaps not the perfect way for the
three parties to do these things—the managers get paid to give up
their property right. If the value and efficiency of the transaction is
large enough, it goes forward, as it would have before the antitakeover
laws, devices, and decisions arose, but managers get a bigger piece of
the pie than they did before.
One need not evaluate here whether the increased managerial
compensation is “incentive” compensation or “rent extraction.”
9
The
check could be seen as tribute to powerful managers, who extract
value from the firm, or it could be seen as a payment contingent on
takeover, thereby aligning managerial incentives with shareholder
value. All we need to know at first is that it is high enough to induce
managers to accede to what would otherwise be a hostile takeover.
10
The takeover-induced pie is, we can believe, about the same in size,
but its division changes. (We pass over how much this Coasean rebar-
gain re-creates the incentives ex ante: Some takeovers do not go for-
ward even with the option-vesting “pay-off” because managers resist
or the offeror withdraws a takeover offer that the increased compen-
sation made more costly.
11
And takeovers’ incentive effects on manag-
ers are reduced by the antitakeover institutional structure, because
managers know that a takeover will put them out of a job but will pay
them handsomely, so there is less for them to fear ex ante, when run-
ning the firm. Yet they presumably compete more heavily for that big
piece of the pie that the CEO can extract. How it all sorts out—more
efficient overall, less efficient overall, or a change in orientation—is
not fully clear in the model. The reequilibration possibly is not the
9 Compare Kevin J. Murphy, Explaining Executive Compensation: Managerial Power ver-
sus the Perceived Cost of Stock Options, 69 U Chi L Rev 847 (2002) (arguing that increased
managerial compensation is based on incentives), with Bebchuk, Fried, and Walker, 69 U Chi L
Rev 751 (cited in note 3) (arguing that increased managerial compensation is due to rent-
extraction by managers).
10 Or, managers are in fact getting incentive compensation. The incentive, though is not
day-to-day compensation, but an incentive to sell the firm to the highest bidder.
11 See Reinier Kraakman, The Best of All Possible Worlds (or Pretty Darn Close), 69 U Chi
L Rev 935 (2002).
1260 The University of Chicago Law Review [69:1255
best way for the players to handle corporate control transfers, but is
just a second or third best. But the point that we get some substitution
effect, and possibly a large substitution effect—Kahan and Rock’s ba-
sic point—is well taken. We will stick with it.)
12
Thus sketched out, we see the economic model in action. The rule
changes, and there is a Coasean reequilibration.
13
(The only “bound-
ary” to the economic model thus far is the question of why managers
win so often in getting antitakeover decisions legislation, the question
we have put aside. But once we take that political boundary as
“given,” as exogenous, the maximizing economic model is back in
play.
14
) If the substitute is close enough, Coase once again shows us
how parties can contract around the rules to make the result effi-
cient—conceivably as efficient as where we started.
That’s enough. And we could stop there. But . . .
II. CULTURAL LIMITS TO THE ECONOMIC MODEL?
Not so fast. Imagine that costs afflict the substitute. If the substi-
tutes were highly costly—for some firms or in varying degrees for all
firms—then a Coasean reequilibration would be harder. Large, mana-
gerial-run firms would be less subject to takeover, and probably run
less well. Some, maybe many, larger managerial-run firms would be
less effective and in time out-competed by smaller ones.
The substitute here for the pure hostile takeover is the quasi-
friendly offer with vesting of heavy stock options that buy off manag-
ers from their opposition. No other substitute, remember, works as
well (we have assumed), and this substitute, even if imperfect, is pretty
good.
12 And for this parenthetical reason, Kahan and Rock’s optimistic variation—with com-
pensation perfectly offsetting the pill—seems possible, but only if serendipity reigns. See Kahan
and Rock, 69 U Chi L Rev 873 (cited in note 4). The question would be how big a loss the three
players suffer—that is, how imperfect the compensation substitute is. A reservation here is that
the new equilibrium, even one with an identical number of takeovers, could be—indeed, should
be, theoretically—at a lower level of shareholder welfare. But this reservation does not implicate
their main claim that there are substitutes, and they implicitly claim that the substitutes are
(nearly) perfect substitutes, or at least good enou
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