Lecture 2 - Key Features of the Corporate Form

Question 1

Scope of Corporate Law

Answer 1

Corporate law responds to “three principal sources of opportunism: [1] conflicts between managers and shareholders, [2] conflicts among shareholders, and [3] conflicts among shareholders and the corporation’s other constituencies, including creditors and employees.” (JOHN ARMOUR p.3)

Question 2

Sources of Corporate Law

Answer 2

o Corporate statutes/codes (Delaware)
o Common law
o US Federal securities laws
o Securities exchange rules (e.g., NYSE)

Question 3

Entity shielding (strong form)

Answer 3

• Priority rule
• Continuity of existence, liquidation
protection

Question 4

Legal Personality (Basic character. of corporations)

Answer 4

o Separate legal persona / patrimony
o Entity shielding
o Rules of authority
o Procedures for lawsuit

Question 5

Limited Liability

Answer 5

Owner shielding – shareholders are protected from the claims of creditors (whether contract or tort) of the corporation

Question 6

Transferable shares (Basic character. of corporations)

Answer 6

o Fungibility of ownership interests
o Enhanced liquidity
o Relationship to liquidation protection and limited liability

Question 7

Delegated management w/board structure (Basic character. of corporations)

Answer 7

o Separation of board from operational mgmt
o Elected board
o Reduces costs of decision-making
o Multiple members

Question 8

Investor Ownership (Basic character. of corporations)

Answer 8

o Allows specialization of roles

o More homogenous ownership class

Question 9

The Dark Side of the Corporate Form

Answer 9

• Personality Issues
• Abuses of Limited Liability
• Unusual Share Transfers
• Abuses of Managerial Power
• Absentee Owner Problems

Question 10

In the economics literature, a firm is often characterized as a ‘nexus of contracts’

Answer 10

coordinating the actions of multiple persons through exercise of its contractual rights

Question 11

‘separate patrimony’ (civil law term)

Answer 11

involves the demarcation of a pool of assets that are distinct from other assets owned, singly or jointly, by the firm’s owners (the shareholders), and of which the firm in itself, acting through its designated managers, is viewed in law as being the owner

Question 12

rule of ‘liquidation protection’ (entity shielding)

Answer 12

Individual owners of the corporation (the shareholders) cannot withdraw their share of firm assets at will, thus forcing partial or complete liquidation of the firm

Question 13

priority rule (entity shielding)

Answer 13

Grants to creditors of the firm, as security for the firm’s debts, a claim on the firm’s assets that is prior to the claims of the personal creditors of the firm’s owners

Question 14

Entity shielding (weak form)

Answer 14

Found in partnerships, which are characterized only by the priority rule and not by liquidation protection.

Question 15

Asset partitioning

Answer 15

◦ permits flexibility in the allocation of risk and return between equity- holders and debt-holders
◦ greatly simplifies the administration of both business and individual bankruptcy
◦ facilitates tradability of the firm’s shares (third characteristic of the corporate form)

Question 16

Types of Corporations

Answer 16

• Publicly-traded (“public”) or privately- held
• Listed or unlisted - applies to public corporations
• Widely-held vs. closely-held (“close”)

Question 17

The Clumsy Side of the Corporate Form – Close Corporations

Answer 17

• May not want perpetual existence, survivability
• May not get the benefit of limited liability
• May eliminate or limit free transferability
• May want to adjust centralized management

Question 18

Default rules of corporate law

Answer 18

◦ provide convenient standard forms
◦ encourage revelation of information
◦ facilitate choice of the most efficient among several alternative rules
◦ provide a means of accommodating, over time, developments that cannot easily be foreseen at the outset

Question 19

Rationale for mandatory terms

Answer 19

♣ based on some form of ‘contracting failure’
• that some parties might otherwise be exploited because they are not well informed
• that the interests of third parties might be affected
• that collective action problems (such as the notorious ‘prisoners’ dilemma’) might otherwise lead to contractual provisions that are inefficient or unfair