summary chapter 1

Question 1

Business corporations have a fundamentally similar set of legal characteristics and face a fundamentally similar set of legal problems in all jurisdictions

Answer 1

almost all large scale busine ss firms adopt this legal form and most small jointly owned firms also adopt it as well, althought sometimes with deviations from one or more of the five basic characteristics to fit their special need.

Question 2

In the economic literature, a firm is often characterized as

Answer 2

a nexus of contracts (most of the important relationships within a firm are essentially contractual in character. However, it is perhaps more accurate to describe a firm as a “nexus for contracts” (a firm serves as the common counterparty in numerous contracts coordinating the actions of multiple persons through exercise of its contractual rights

Question 3

The core element of the firm as a nexus for contracts is

Answer 3

separate patrimony: which involves hte demarcation of a pool of assets that are distinct from other assets owned (single or jointly) by the firms owners and of which the firm itself is viewed in law as being the owner.

Question 4

The core function of this separate patrimony has been termed

Answer 4

entity shielding, the emphasize that it involves shielding the assets of the entity from the creditors of the entitys owners.

Question 5

Entity shielding involves two relatively distinct rules of law

Answer 5

priority rule: grants to creditors of the firm, as security for the firms debts, a claim on the firms assets that is prior to the claims of the personal creditors of the firms owners

Rule of liquidation protection: provides that the individual owners of the corporation cannot withdraw their share of firm assets at will nor can the personal creditors of an individual owner foreclose on the owners share of firm assets

Question 6

For a firm to serve effectively as a contracting party, two other types of rules are also needed

Answer 6

there must be rules specifying to third parties the individuals who have authority to buy and sell assets in the name of the firm, and to enter into contracts that are bonded by those assets

There must be rules specifying the procedures by which both the firm and its counterparties can bring lawsuits on the contracts entered into in the name of the firm

Question 7

Limited liability

Answer 7

The corporate form effectively provides a default term in contracts between a firm and its creditors whereby the creditors are limited to making claims against assets that are held in the name of the firm itself, and have no claim against assets that the firms shareholders hold in their own names
Limited liability shields the firms owners from creditors claims, which facilitates diversification as limited liability imposes a finite cap on downside losses, making it feasible for shareholders to diversify their holdings

Question 8

Transferable shares

Answer 8

transferability permits the firm to conduct business uninterruptedly as the identity of its owners changes, thus avoiding the complications of member withdrawal. This in turn enhances the liquidity of shareholders interests and makes it easier for shareholders to construct and maintain diversified investment portfolios.

Question 9

Fuly transferable shares do not neessarily mean freely tradable shares.

Answer 9

even if shares are transferable, they may not be tradable without restriction in public markets, but rather just transferable among limited groups of individuals or with the approval of the current shareholders or of the corporation. Corporations with freely tradable shares are “open” or “Public” corporations, and “closed” or “private” corporations refer to corporations that have restrictions on the tradability of their shares

Question 10

In addition to this division, two other distictions are important

Answer 10

shares of open corporations may be listed for trading on a stock exchange “listed” or “publicly traded” corporation (as opposed to “unlisted” corporation)

Shares may be held by a small umber of individuals whose interpersonal relationsihps are important to the management of the firm “closely held” (as opposed to “widely held”)

Question 11

centralized (delegated) management under a board structure

Answer 11

corporate law typically vests principal authority over corporate affairs in a board of directors or similar body that is periodically elected, exclusively or primarily, by the firms shareholders.

Question 12

The board of directors has four basic features

Answer 12

The board is separate from the operational managers of the corporation. The legal distinction between them formally divides all corporate decisions that do not require shareholder approval into those requiring approval by the board of directors and those that can be made by the firms hired officers on their own authority

The board of a corporation is elected by the firms shareholders. THe utility of this approach is to help assure that the board remains responsive to the interests of the firms owners

Though largely or entirely chosen by the firms shareholders, the board is formally distinct from them

The board ordinarily has multiple members. THis structure facilitates mutual monitoring and checks idiosyncratic decision making

Question 13

Shared ownership by contributors of equity capital (investor ownership)

Answer 13

in an investor owned firm both the right to participate in control and the right to receive the firms residual earnings, or profits, are typically proportional to the amount of capital contributed to the firm.

Question 14

The dominance of investors ownership among large firms refleects several conspicious efficiency advantages:

Answer 14

among the various participants in the firm, investors are often the most difficult to protect simply by contractual means

Investors of capital have relatively homogeneous interests among themselves, hence reducing the potential fro costly confict among those who share governance of the firm

Question 15

The relationships among the participants in a corporation are, to an important degree, contractual

Answer 15

the principal contract that binds them is the corporations charter, which sets out the basic terms of the relationship. At the same time, corporations are the subject of a large body of statutory law.

Question 16

A significant part of corporate law consists of default provisions

Answer 16

to this extent corporate law simply offers a standard form contract that the parties can adopt, at their option, in whole or in part. A common form of corporate law default is a statutory provision that will govern unless the parties explicitly provide an alternative. Alternatively, corporate law itself sometimes specifies the rule that will govern if the default provision is not chosen an “either-or” provision. In other words, the law in this case gives the corporation a choice between two statutory provisions: one is the default and the other is the secondary provision, with the latter applying only if the firm opts out of the default

Question 17

There are also important rules of corporate law that are mandatory leaving parties no option but to confirm to them. The reationale for mandatory t ems of these types is usually based on some form of contracting failure. Mandatory terms may also serve a useful standardizing function, in circumstances where the benefits of compliance increase if everyone adheres to the same provision. Mandatory rles need not just serve a presecitpive function however. When used in conjuction with a choice of corporate forms they can perform an enabling function similar to that served by default rules. The law accomplishes this by creating corporate forms that are to some degree inflexible, but then permitting choice among different corporate forms. There are two principal variants to this approac h

Answer 17

A given jurisdiction can provide for a menu of different standard form legal entities from which parties may chose in structuring an organization

The organizers of a firm may often choose among different jurisdictions laws

Question 18

the overall objective of corporate law -as any branch of law-

Answer 18

is presumably to serve the interests of society as a whole. more particularly, the appropriate goal of corporate law is to advance the aggregate welfare of those who are affected by a firms activities. This is what economists would characterize as the pursuit of overall social welfare

Question 19

It is sometimes said that the appropriate role of corporate law is simply to maximize financial returns to shareholders or more specifically to maximize the current market price of corporate shares. such claims can be viewed in two wasy

Answer 19

these claims can be taken at face value, in which case they neither describe corporate law as we observe it nor offer a normatively appealing aspiration for that body of law

focusing principally on the maximization of shareholder returns is, in general, the best means by which corporate law can seve the broader goal of advancing overall social welfare. in general, creditors, workers, and customers will consent to deal with a corporation only if they expect themselves to be better off as a result. COnsequently, the corporation has an interest in making sure that corporate transactions are beneficial to all parties who deal with the firm

Question 20

What forces shape corporate law

Answer 20

The particular contours of the problem to which corporate law responds may be in part determined by aspects of the corporate governance environment - for example: predominant industry type, institutions governing employee relations and the structure of share ownership