IBCL-CL2_2023-24_Part_I_Unit_1_Section_2-5(revised).pdf

IBCL/CL2 A.Y. 2023-2024 (2nd SEMESTER) (prof. Maurizio Bianchini) PART I - UNIT I Sections 2, 3, 4 (A, B, C, and D), and 5 “Legal Personality” The company as a form of Business Organization (“BO”): its forms,...

IBCL/CL2 A.Y. 2023-2024 (2nd SEMESTER) (prof. Maurizio Bianchini) PART I - UNIT I Sections 2, 3, 4 (A, B, C, and D), and 5 “Legal Personality” The company as a form of Business Organization (“BO”): its forms, the sources of its rules its quasi-contractual nature, the agency model, the corporate contract main characteristics, and some closing remarks on Unit 1  WHERE WE STAND: A QUICK REMINDER ABOUT THE BASICS OF BUSINESS ORGANIZATIONS  Again, please have a look to the word «organization» multiple meanings;  Every form of Business Organization:  is indeed an …. «organization» of labor (people) and capitals (money/land/assets):  traditionally, serves as an «investment vehicle» o input = pooling of capital (and labor) from different sources; o Capital has no longer significant boundaries => international investments;  traditionally, serves as a «business vehicle», since BOs typically engage in one or more trades or businesses o output = product and/or services to be placed in the relevant market(s); o carrying out business is their «reason of life» (incorporated firms have not a life on their own, separate from their business purpose!); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  WHERE WE STAND: THE 5 LEGAL CHARACTERISTICS OF THE MODERN CORP. From a firm (and, thus, from a Business Organization Law) perspective, we learnt that the «Modern Corporation» is characterized by 5 common legal features that, today, tend to be found in every State’s corporate law (or Law of Business Organizations) in the World, as a by-product of the “darwinian” evolution of the capitalistic economy and, lastly, as a consequence of the socio-economic globalization process: 1. Legal personality; 2. Delegated management 3. Investors’ «ownership»; 4. Free transferability of the equity interests (shares); 5. Limited liability privilege; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  IBCL/CL2 A.Y. 2023-2024 (2 ND SEMESTER) (PROF. MAURIZIO BIANCHINI) Exploring «legal personality» PART I - The company as a form of business organization: UNIT I – the types of business organizations SECTION 2  TYPES OF BUSINESS ORGANIZATIONS IN EUROPE Business associations/Organizations (UK-Europe): Sole Proprietorship Sole Entrepreneur Single Business Owner Companies ( (residual) Partnerships (Annex 1, Directive 1132/2017/EU) «Public Limited Liability Unlimited General Companies» (e.g. SPA) «Close companies» Business Partnerships Partnerships Limited Publicly-Held Closely-Held Limited Liability Business Companies Companies Companies Partnerships (if stocks are listed) (if shares are not listed) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  TYPES OF BUSINESS ORGANIZATIONS IN THE USA Business Associations/Organizations Sole Proprietorship Sole Entrepreneur Single Business Limited liability Incorporated Business Unincorporated Owner Companies Associations (Legal Entities) Business Associations (residual) («Hybrid Entities») Unlimited/ Limited C-corporations S-Corporations General Partnerships (tax classification) (tax classification) Partnerships (GP) (LP) Member- Manager- Managed Managed Publicly-Held Limited LLC LLC Limited Liability Corps. Privately-Held Liability Limited (listed Corps. Partnerships Partnership Companies) (LLLPs) (LLPs) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved Overview of “common law” (Anglo-American) Business Organisations Forms Type of Entity Liability Capital contributions Management Unlimited personal liability for the Any capital needed for the trade(s) or Business is managed by the sole proprietor Sole Proprietorship / Sole “Entrepreneur” obligations of the business business(es), in cash or in kind, is to be contributed by sole proprietor Unlimited personal liability of the general Partners contribute cash, in kind, or services to The partners have equal management rights, partners for the obligations of the business the partnership; they share profits and losses unless they agree otherwise in the PSA; according to the Partnership agreement (“PSA”), Generally, agency law provides rules that will General Partnership or, by default, in equal/proportionate share protect third parties (partnership’s creditors) reliance on “apparent” authority of partners. Unlimited personal liability of the general Partners contribute cash, in kind, or services to The general partner manages the business, partners for the obligations of the business; the partnership; they share profits and losses subject to any limitations of the Limited PSA; limited partners generally have no personal according to the Limited PSA, or, by default, in Generally, agency law provides rules that will Limited Partnership liability equal/proportionate share protect third parties (partnership’s creditors) reliance on “apparent” authority of partners Generally, no personal liability of the Members contribute money or services to the All of the members are agents of an LLP; rights Limited Liability Partnership members for the obligations of the business limited partnership; they share profits and losses and duties are governed by the LLPSA Generally, no personal liability of the No minimum capital requirements. However, Company is managed through its managing members for the obligations of the business equity capital can be raised through the issuance director(s), or by the board of directors acting of “quotas” to members or through a guarantee as a collective body (majority, supermajority -Private Limited Company (Ltd) [British Law/ rules may be provided for under the Ltd. Company Act of 2006, as amended (“CA 2006”)] Articles of association and/or by the company’s “statute” or “by-laws”/”LLC’s operating -Limited Liability Company (LLC) [US State Laws] agreement”); individual, group, or all members may be directly involved in the management, according to the company’s agreement No personal liability; liability is generally -UK CA 2006: The minimum share capital of Company is managed by the board of limited to shareholder contributions (ie £50,000 is raised through issuance of shares to directors; shareholders have no power to consideration for shares) the public and/or existing members; participate in manage- ment Public limited company (plc) [British Law/CA 2006] - US states usually do not impose minimum Corporations (Inc./Corp.) (Close/Privately-Held, capital requirement; specific debt/equity ratios and/or Public/Publicly-Held) [US State/Federal may be imposed for specific trade(s) or Laws] business(es) and/or if the company is taken “public” IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  NOTE ON U.S. CORPORATE NOMENCLATURE  Sometimes, there is some confusion about what is meant by "private corporation" and "public corporation,” under U.S. company law: o A "private corporation" generally refers to a non-governmental, for-profit business that has been incorporated under a state statute (e.g., under DE laws). Usually, a “private corporation”:  can be participated by a few shareholders: and then it is referred to as a "closely-held corporation" or "close(d) corporation“, or  the private corporation can be participated by many shareholders whose shares are traded on securities markets such as, e.g., the New York Stock Exchange, Nasdaq, etc: and then it is referred to as a "publicly held corporation" or "public corporation." [See MBCA §1.40 (Definition 8A)]. o Thus, for example:  “Apple Inc.” is a "private corporation" (it is not controlled by the State nor by any State authority), which happens to be also a "public corporation" (i.e., a “listed” corporation: the shares are traded in securities markets);  “Mom & Pop Grocery Corp.” is a "private corporation" that is also a "close corporation;” IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  NOTE ON U.S. CORPORATE NOMENCLATURE/2 …...  Trying to keep things simple, we will avoid the term "private corporation" when referring to U.S. companies (we will only use public/publicly-held corporation or close/closely-held corporation);  Of course, there are some corporations that are governmental, such as, in the U.S.A., the Federal Deposit Insurance Corporation. The FDIC, a government agency established to insure bank deposits, was created by an act of U.S. Congress and is governed by a board of governors whose members are appointed by the president. Although some people might call the FDIC a "public corporation," it is clearer to call it a "governmental agency" (that has been organized in a corporate form); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  DISTINCT STATUTORY FORM SPECIALIZED FOR THE FORMATION OF “CLOSE CORPORATIONS” major jurisdictions commonly have at least one distinct statutory form specialized for the formation of “close” (or “closed” corporations (privately held company; private company; limited liability company).  Examples: the French SARL, the German GmbH, the Italian Srl, Japanese close corporation, the American close corporation and (more recent) limited liability company, and the UK private company;  In the case of the UK private company, the standard form is provided not by a separate statute, but by a range of provisions in a single statute (the Company Act of 2006) with differential application to “public” and “private” companies; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  DISTINCT STATUTORY FORM SPECIALIZED FOR THE FORMATION OF “CLOSE CORPORATIONS”  These company (standard) forms typically exhibit all of the canonical features of the corporate form.  They differ from publicly-traded companies: chiefly because their shares (quotas), though transferable at least in principle, are presumed —and in some cases required— not to trade freely in a public market; and sometimes because these forms also permit departure from one of our five core characteristics —delegated management— by permitting elimination of the board, in favor of direct management by shareholders (member-managed companies);  The statutes creating these forms also commonly permit, and sometimes facilitate, special allocations of control, earnings rights, and rights to employment among shareholders that go beyond those permitted in the core public corporation statute; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  PUBIC COMPANIES VS. PRIVATE COMPANIES UNDER EU LAW (DIRECTIVE 2017/1032/EU)  UK Company law calls the “corporation” “public limited company” (“PLC”) even if none of the shares of that type of company are traded in any securities market(s);  This creates an additional layer of … confusion!  Here, «Public» means «ready to go public», but not necessarily «listed» (yet); under UK Company Law, «public limited companies» are opposed to «private limited companies», i.e., limited liability companies («Ltd.»);  Thus, «Public companies» under the EU Company Law Directive (no. 2017/1032/EU) are «companies» that under US law may be either «public corporations (publicly held/publicly traded) or a close corporation (privately held company, different from a «limited liability company»)  Note that the EU Company Law Directive was passed when UK was still part of the EU and the «public limited company» name was used in that directive probably to please a UK government’s request: so that, now, the UK nomenclature characterizes the Directive no. 2017/1032/EU, even if, meanwhile, UK «exit» the EU! IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  IBCL/CL2 A.Y. 2023-2024 (2 ND SEMESTER) (PROF. MAURIZIO BIANCHINI) The company as a form of business PART I - organization: UNIT I – the sources of its governance rules SECTION 3  THE SOURCES OF COMPANY LAW Organizational Rules => corporate governance rules: they are typically sourced: o At law (e.g., Delaware General Corporation Law; Italian Civil Code; etc.):  Mandatory provisions: cannot depart from their prescriptions;  Default/residual provisions: can be waived and/or departed from by contractual arrange-ments that are supposed to better reflect the parties’ intents: default norms are intended as solutions «proposed» by the enabling statute’s ; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE SOURCES OF COMPANY LAW (continued) Organizational Rules => corporate governance rules: they are typically sourced: o At contract (where the Organizational Law authorises/enables contractual arrangements) => contractual relationships/arrangements fill the gaps left open by the law – the law cannot fully regulate every aspects of human relationships;  (business) usages (customary rules) as a complemental source of organizational rules, where contract law allows for such usages’ gap- filling role;  Codes of conducts: «club rules» = rules whose respect is imposed to any person wishing to opt-in a specific regime (they are mostly contract rules);  Judicial norms (court’s decisions): Common Law vs. Civil law traditions: different «normative value» attached to precedents; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  IBCL/CL2 A.Y. 2023-2024 (2 ND SEMESTER) (PROF. MAURIZIO BIANCHINI) The corporation as a form of business organization: PART I, UNIT I, the long-debated ‘contractual nature’ SECTION 4.A of the company  THE DEBATED CONTRACTUAL NATURE OF THE MODERN (PRIVATE, FOR-PROFIT) CORPORATION  most legal scholars believe that the company’s “articles of association” (or “articles of incorporation”) and the annexed “by-laws” shall fall within a special type or set of contracts: the so-called “organizational contracts”;  Note: sometimes “by-laws” are called “statutes”, especially in Europe: therefore, beware of the distinction between “statute” = legislative act, usually an act of the Parliament that contains general legal rules; and “statutes” which are contractual arrangements meant to provide organizational rules to run the “company’s life”;  however, others think that the “articles of incorporation” cannot be qualified ad contracts, because companies are state-created entities, although they bear with them some contractual features (thus one may say that they are “quasi-contract”); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE CONTRACTUAL NATURE OF MODERN (BUSINESS) CORPORATION  Prof. Butler in his 1989 article on the «contractual theory of the corporation» wrote: o “Economists […] have only recently begun to understand the economic nature of the corporation. In the last fifteen years [note that Jensen & Meckling essay dates back to 1976], the economic theory of the firm has advanced from a struggle with the identification of the economic conditions that lead to the formation of firms to a discourse on sophisticated issues concerning intrafirm relationships”; o “As a consequence of these developments, economists have come to view the firm as a ‘nexus of contracts’ among participants in the organization”; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE CONTRACTUAL NATURE OF MODERN (BUSINESS) CORPORATION  (continued) Prof. Butler 1989 essay: o By reason of this finding, in the US law, “[w]hen applied to the corporate form of organization, the theory of the firm is often referred to as the contractual theory of the corporation”; o “The contractual theory of the corporation is in stark contrast to the legal concept of the corporation as an entity created by the state” ; o “The entity theory of the corporation supports state intervention – in the form of either direct regulation or the facilitation of shareholder litigation – in the corporation on the ground that the state created the corporation by granting it a charter”; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  BUSINESS ORGANIZATIONS: (CONTINUED) CONTRACTUAL NATURE OF MODERN CORPORATIONS  (continued) Prof. Butler also added that: o “Instead, “[t]he contractual theory views the corporation as founded in private contract, where the role of the state is limited to enforcing contracts. In this regard, a state charter merely recognizes the existence of a ‘nexus of contracts’ called a corporation”; o “Each contract in the ‘nexus of contracts’ warrants the same legal and constitutional protections as other legally enforceable contracts. Moreover, freedom of contract requires that parties to the ‘nexus of contracts’ must be allowed to structure their relations as they desire”;  the corporation as a “legal entity” has been re-cast as a set of contractual or quasi- contractual relationships and more spe-cifically as a “nexus of contracts” by Jensen & Meckling in 1976: the NOCs theory is the bulk of the “contractarian nature” theory of the modern corporation in the USA; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved (CONTINUED) THE CONTRACTARIAN THEORY OF THE MODERN CORPORATION the corporation as a “legal entity” has been re-cast as a set of contractual or quasi-contractual relationships and more spe- cifically as a “nexus of contracts” by Jensen & Meckling in 1976 the “nexus of contracts” theory is also called “contractarian theory” of the incorporated firms: Company/Corporate law, while maintaining its formal hierarchical position within the legal system (contract law and company law are subject to mandatory legal rules), could really be intended as a set of default contract clauses, offered to the market by the legal system of incorporation (=> market for legal rules => regulatory competition => “Delaware effect” => problem of the possible triggering a “race to the bottom”, instead of a “race to the top”); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE DEBATED NATURE OF THE MODERN (CONTINUED) CORPORATION: A VIABLE MIDDLE GROUND SOLUTION Both Contract law and Company (or Corporate) law, are part of state law (just like criminal law, tort law, labor law, etc.) and they are enacted to regulate firms within the general “umbrella” provided by the very general “enterprise freedom” clause set forth in virtually all contemporary constitutional charters; that means, in practice, that both contract law and company law are subject to the rule of law and mandatory legal rules)…. Thus, every legal system – through its own (business organization law) rules –retains and exercises the sovereign authority both (a) to “recognize” the very existence of a company and (b) to “regulate” its ability to operate in the market as a “person”: it is often said that companies are “creatures” of state law; However, “Company IBCL/CL2 A.Y. 2023-2024 law” ©Maurizio could be2024intended Bianchini – All Rights Reserved as a set of default contract clauses, offered to the market agents by the legal system  THE DEBATED NATURE OF THE MODERN (CONTINUED) CORPORATION: A VIABLE MIDDLE GROUND SOLUTION However: because every State needs to balance “authority” and “business freedom” in order to foster its economic system and to compete with other legal systems (market for legal rules => regulatory competition)… ….. “Company law” has been increasingly crafted (and it could therefore be studied), as a set of default contract clauses, offered, like any product placed on the shelf of a supermarket, to the market agents by each legal system of incorporation: it enables the formation and, to a good extent (i.e., unless mandatory rules compress freedom of contract) the organizazion of the governance rules of the company; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE DEBATED NATURE OF THE MODERN (CONTINUED) CORPORATION: A VIABLE MIDDLE GROUND SOLUTION Consequently, the legal instrument whereby a company (or corporation) is formed (“articles of incorporation”, “articles of association”, “charter”, “statutes”), under the laws of any given legal system (sometimes we will use the term “jurisdiction”), is a very peculiar type of contract, that will almost inevitably bears, both: (a) “private ordering” (freedom of contract) features, and (b) “public ordering” elements, typically concerned with (b.1) the grant of the “legal personality” to the business organization, that thus becomes an “incorporated firm”; and (b.2) a set (which is still variable, depending on the specific jurisdiction enacting the company law rules that will govern the incorporated firm) of mandatory organizational and operating legal rules to which any company incorporated (or operating) under the laws of that jurisdiction must abide by; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  IBCL/CL2 A.Y. 2023-2024 (2 ND SEMESTER) (PROF. MAURIZIO BIANCHINI) The corporation as a form of business organization: PART I, the nature of the company, the legal UNIT 1, aspects of the «agency relationship» SECTION 4.B and the «agency costs theory»  THE COMPANY’S MOST IMPORTANT «LEIT MOTIV»: THE PROBLEMS OF GOVERNANCE AS PROBLEMS OF «AGENCY»  What is an “agency” relationship?  Dual approach:  “legal” and  “economic”  “transaction costs”?  Jensen and Meckling “agency costs theory” IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION  “Intermediate between contract and firm is the principal-agent relationship” (P OSNER , Economic Analysis of Law, Aspen Publ., 2007, p. 420, fn. 3) o Agency is the relationship created when a "principal" consents to another person (the "agent") to act on her behalf and/or under her general control, and the agent consents to this relationship, with the object of bringing the “principal” into legal relations with third parties (e.g., I, the principal, entrusting my brother, the agent, to sell my car to Mr. Smith, while I am enjoying my “sabbatical” in Australia);  “[t]he most basic business organizational form is the principal-agent relationship” (A.R. Palmiter, Corporations, 9 th ed. Wolters Kluwer, 2021 , p. 24) ; o Agency is considered as the “simplest form of joint economic undertaking”, since “one person extends the range of her own activity by engaging another to act – or transact – on her behalf” (A LLEN-K RAAKMAN , Commentaries and Cases on the Law of Business Organization, Aspen-Wolters Kluwer, 2016, p. 7) ; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION  (continued) The most basic business organization is the principal-agent relationship. o For example, the “employer-employee relationship” is a specific principal-agent relationship, also called “master-servant relationship”, where the employer, under the terms of the labor contract(s) reserves the right to instruct the employee on what his/her tasks should be and to control her/his conduct when performing his/her services and usually owns, or exerts control over, the instruments /tools assets used by the employees in carrying out their tasks and duties; o Division of labor finds its way in XIX century factories, and firms gene- rally, because the employers had the “contractual leverage” to impose an increasing specialization of roles and/or functions to their employees (=> firm = hierarchical structure); of course, this is still true today; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  AGENCY THEORY AND THE BUSINESS ORGANIZATIONS Business Organizations (BOs) are meant; 1. to last for a significant lapse of time, and possibly to survive to its founders (incorporators, founding partners), and 2. to operate by means of its “organizational rules”, resulting from a mix of legal and special kind of contract rules, intended to deal with open-ended situations and future decisions: those rules, are sourced (derived) from both the operation of laws and by parties’ freedom of contracting (=> “tailoring” default legal rules); 3. Since the most basic business organizational form is the prin- cipal-agent relationship (retro), we may expect this relationship to play a relevant role also in more sophisiticated types of BOs; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  According to the contractual nature of the company, and being the company a coordinated set of (organizational) rules intended to coordinate and to govern an array of different relationships…… ….. the “agency relationship” can be used as a “model” (a modular unit) to understand those relationships created by the company contract, thereby offering a powerful “tool” to analyze the “costs” associated to the choice of incorporating and managing business firms, as compared to other business organizations forms; This is why the corporation as a “legal entity” has been re-cast as a set of contractual or quasi-contractual relationships and more specifically as a “nexus of contracts” by Jensen & Meckling in 1976: the “nexus of contracts” theory is also called “contractarian theory of the (incorporated) firm”; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION: THE LEGAL APPROACH  A gency law/1: Formation, termination and scope of an agency relationship: o Agency is a “consensual” – that is contractual – relationship between: o a “Principal” who grants authority to another person, the Agent, to carry out on the P’s behalf, some actions and/or specific transactions (contracts) that will be directly binding the Principal, and o the “Agent”, who accepts to act on behalf of the principal, which imports to act also in the P’s best interest;  freedom to enter into such relationship (=> freedom of contract);  an agent is granted a power to affect the principal’s legal relations with third parties within the scope of the agency’s agreed-on appointment;  an agent can legitimately act beyond the scope of the authority granted by the P, only in some limited and selected circumstances; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION  (continued) The most basic business organization is the principal-agent relationship o Agency is a contractual relationship: o agency law enables an “agent” to create rights and obligations between a “principal” and third parties, o whereas the Agency relationship is still considered “contractual” in nature (is created by means of a contract), it shall be governed by the law (mandatory rules on agency), as well as “private ordering” (the parties to the agency relationship “craft” their own rules and/or adapt default legal rules to their specific needs); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION  Agency as a contractual relationship: o Four main problems: 1. Formation and termination of an agency relationship; 2. The scope of the “agent”’s power to act/transact on behalf of the “principal”; 3. Principal’s relationship to third parties with whom the agent did (or may) have acted/transacted; 4. What are the duties owed by the agent to the principal and vice versa? IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION  it is irrelevant whether the parties did expressly characterize their rela- tionship as principal-agent: sometimes, this relationship arises if the circumstances of the case and/or equity considerations suggest that there should have been an agency between the parties, or if a third party reaso- nably and in good faith relied on the mere (but reasonably convincing) “appearance” of an agency relationship between an apparent agent and an apparent principal;  Tort’s law rules may also step in (besides contract law rules): “respondeat superior” doctrine: the “principal” may be held responsible for her agent’s action(s) if those actions can be deemed, in the light of the circumstances, “reasonably within the scope” of the agency relationship for whom must it be “reasonable” (whom point of view shall we use to determine whether the agents’ actions fell within or without the scope of the agency relationship?) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION  A gency law/1: Formation, termination and scope of an agency relationship: o With regard to the scope of their authority, Agents may be: o “special agents” (agency authority is limited to a single act or transaction: e.g., my brother acts as an agent in selling my car; he cannot sell my garage); o “general agents” (agency authority contemplates a series of acts or transactions of a given types scope value etc.); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  AGENCY LAW: FORMATION TERMINATION AND SCOPE OF AN AGENCY RELATIONSHIP:  Express appointment vs. Implied appointment vs. Agency ‘ex lege’ (Note: this is connected to the scope of the “Authority of the Agent = scope of the power to represent/to act on behalf of the principal) o ‘Ex lege’ agency powers: the (contract/tort/business) law directly and auto- matically creates an agency relationship in connection with some specific relationships arising on a voluntary basis (contract) or as a consequence of some facts (torts) or simply by operation of law; o E.g.: Executive Directors of the company (managing directors) retain the power to act on behalf of the company to the extent (and sometimes even beyond) of the scope of their respective delegated managing authority; o Some top corporate managers and even employees specifically entrusted with the responsibility to deal with third parties (e.g., with firm’s suppliers) can act on behalf of the business (e.g., signing supply contracts on behalf of the firm) if actions fall within the scope of the employee’s responsibilities; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION  (cont’d) Agency law: Express vs. Implied authority o “Express Authority” depends on what the Principal(s) empowered/ delegated the Agent(s) to do on an express basis (written or orally):  A specific transaction (I empower an agent to sell my car);  Specific types of transaction(s): Agent (A) empowered to sell cars of a car dealer (P); A cannot sell trucks; A cannot sell the whole business of the car dealer; or: A empowered to procure new clients for the P’s business: A cannot procure new suppliers);  General authority to act on behalf of the principal(s) under every (legal) respect: agent is entrusted with the general authority to deal with all the transactions concerning the principal’s assets (A can sell or let the P’s home, car, etc.); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION  (cont’d) Agency law: Express vs. Implied authority o “Implied Authority” usually comes with express authority: it is the agent’s additional power to do whatever is necessary for the prudent (diligent) execution of the “express authority” in the proper (most effective) manner; it may also be inferred by the specific type of transaction at stake, custums and usages of the specific market where the transaction takes place;  Within the business law (and business organizations law) implied authority sometimes overlaps with the notion of “authority ex lege”: it is the law, not only custom or usages that provides A (e.g., a firm’s manager, an employee) with additional authority (beyond the express authority) to act on behalf of P (an undertaking, e.g., a company) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  AGENCY LAW: FORMATION TERMINATION AND SCOPE OF AN AGENCY RELATIONSHIP  The problems with the “scope of the Agent’ authority” (= power to represent/to act on behalf of the principal)  the general rule is that the agent’s authority can never exceed the limits (that is the scope, the “perimeter”) of her principal’s authority (the principal cannot grant the agent more authority than what the principals has, e.g.: P cannot give A the authority to sell a house P does not own);  that is, the agent cannot exceed what her principal hereself is legally empowered to do (e.g.; Principal could herself be an agent of another principal: Principal => Agent+Principal => Agent); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION: THE PROBLEM OF «APPARENT AUTHORIT Y»  Moreover, under the preceding rules, P should not be bound to third parties if A did act, in the principal’s name, but outside the scope of (a) express authority granted by the principal + (b) implied authority, unless either: (1) It will be found that: (1.a) the principal did, in fact authorize the agent to carry out the specific action or transaction in question (even impliedly), or (1.b) the authorization was granted by the Principal (even impliedly) after the bindind act was carried out => ratification of the agent’s actions, or (next slide please) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION: THE PROBLEM OF «APPARENT AUTHORIT Y»  (cont.d) Moreover, under the preceding rules, P should not be bound to third parties if A did act, in the principal’s name, but outside the scope of (a) express authority granted by the principal + (b) implied authority, unless either: (2.a) something in the principal’s behavior, and taking into consideration all the circumstances (including: the specific type of principal(s) and the specific type of agent(s), the markets usages; the specific type of action and/or transaction at stake), let the third party reasonably infer that the agent was indeed granted by the principal the necessary authority carry out any specific transaction (that is, the principal’s behavior was ambiguous so to reasonably allow a diligent third party believe that, indeed, the agent acted within the scope of her actual authority), and (2.b) the principal’s behavior was reasonably relied upon by third parties; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  AGENCY LAW: FORMATION TERMINATION AND SCOPE OF AN AGENCY RELATIONSHIP  (cont.d) The problems with the “scope of the Agent’ authority” (= power to represent/to act on behalf of the principal)  What is the difference between implied and apparent authority? “Implied authority” usually complements some kind of express authority, and it arises directly from the nature of an agent’s role and/or from customary duties and/or usages that are found in a specific context (e.g., usages entrenched within a specific market); “Apparent authority”, emerges from the principal’s actions or statements that lead third parties to reasonably believe, in good faith, that an agent has been given certain authority by her principal(s) and to reasonably rely on that authority when dealing with that agent in connection with a specific transaction; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION Under Agency Law, the principal-agent relationship creates mutual duties: o If, on one side, the principal must honour all obligations that arise between the agent and third parties in contract or tort …. o …on the other side, the agent must put the principal’s interests ahead of her own; o The agent is bound by a duty of care, a duty of “utmost good faith” and a duty of loyalty to her principal => fiduciary duties  Agents cannot compete directly with her principal(s) on her own, nor as an agent of a rival company.  Agents cannot misappropriate/embezzle principal’s profits, property, or “business opportunities”;  A. cannot breach her principal’s confidences (confidentiality obligation); An agent who fails to act solely for the benefit of her principal is liable for the profits she earned in violation of her duties, in additional to other damages (Note that, in some jurisdictions, no actual injury to the principal need be proved in court); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  BACK TO THE «AGENCY RELATIONSHIP» AS THE BASIC FORM OF BUSINESS ORGANIZATION  Agency relationships typically generates long-term, relational, cooperative type of relationships, that are difficult to regulate completely (=> “incomplete contracts” category) and to monitor effectively: it generates costs => agency costs  the agent is usually granted some discretion on when, where, and/or how to carry out the agency;  the agent may have (or have access to) more information than the principal with respect to the transaction (or series of transactions) that the agent is supposed to carry out on behalf of principal under the agency relationship (“asymmetry of information” problem);  Agency is a “fiduciary” and co-operative type of (contractual) relationship rather than an “arm’s length”/adversarial relationship: the nature, identity and behavior of the parties is very important; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION  (continued) The most basic business organization is the principal-agent relationship. o Agency as a contractual relationship:  Does the agency relationship belong to the «descrete contracting model», or to the long-term, «relational contracting» model?  Is/are any of the parties (or both) exposed to any type of «asymmetry of information» that would impinge on «bounded rationality» and/or on «risk»? Is/are one or both parties exposed to the «opportunism» of the other?  Can we «apportionate»/ «allocate» any «property right» (in the Hart’s sense) among principal(s) and agent(s)?  What is, the essence of the relationship? On what basic non-legal feature is it ultimately based? IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY» AS BASIC FORM OF BUSINESS ORGANIZATION  Why are we interested in agency law?  because, since “Intermediate between contract and firm is the principal-agent relationship” (P OSNER , Economic Analysis of Law, Aspen Publ., 2007, p. 420, fn. 3) ;  ….“[t]he law of Agency prefigured some of the basic problems in corporate law”:  The incorporated firm (company) is a fictious “entity”, it can be thought as a “principal” that (currently, at least) needs human “agents” to operate in the market on its behalf: agency law principles apply to those who are to “represent” the Business O Organizations (Bos) with third parties (e.g., signing the contract to rent out the plant where a BO will manufacture its products);  “Indeed, these problems are heightened in the context of a widely held public corporation because the putative ‘principal’ – often dispersed shareholders in large U.S. corporations – may be incapable of monitoring IBCL/CL2 A.Y.its ‘agent’ – the corporation’s 2023-2024 management” ©Maurizio Bianchini 2024 – All Rights Reserved ; (ALLEN-KRAAKMAN, Commentaries and Cases on the Law of Business Organization, 5th ed., Wolters Kluwer, 2016, p. 7)  AGENCY THEORY AND THEORY OF THE MODERN CORPORATION: THE ECONOMIC APPROACH being the company a coordinated set of both (a) legal rules and (b) contractual (organizational) arrangements, intended to coordinate and to govern an array of different (contractual) relationships…. ….the “agency relationship” can also be used as a “model” (a sort of modular unit) useful to understand those relationships created by the company contract (of course, within the scope permitted by the law), thereby offering a powerful “tool” to analyze the “costs” (including “social costs”) associated to the choice of incorporating and managing business firms, as compared to other business orga- nizations forms; the “Law & Economics” perspective is always loo- king for mechanisms, organizational solutions, etc., that would help in economizing on transaction costs and, thus, also on “agency costs”; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE COMPANY’S MOST IMPORTANT «LEIT MOTIV»: THE PROBLEMS OF GOVERNANCE AS PROBLEMS OF «AGENCY»  Law & Economics scholars used the “agency relationship” as a “model” to re-qualify the relationship between: the shareholders (firm’s equity providers/residual claimants) and the (incorporated) firm’s top management (board of directors and top- ranking officers, CEO, COO, CFO etc.)  However, we should be aware the “agency model” is just one possible explanation of the complexity of the “modern company” model;  in addition, we should be aware that any agency relationship bears “costs”, to both the “principal(s)”, and to the “agent(s)” that are called “agency costs”: if these costs are too high and/or unmanageable, then the parties may avoid the transaction altogether: the law should then provide sufficient protection to make agency relationships viable; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  Jensen & Meckling: “Theory of the firm: Managerial Behaviour, Agency Costs and Ownership Structure” (1976): o «If both parties to the [agency] relationship are utility maximizers, there is good reason to believe that the agent will not always act in the best interests of the principal», o i.e., if both parties to the agency relationship will try to pursue their respective best interest, then one could reasonably expect that the agent(s) will act opportunistically against her principal(s); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  Opportunism = «self interest with guile» (Williamson): a «moral hazard»: it may be described as the knowingly taking advantage of somebodyelse deficiency (e.g., taking advantage of own’s information supremacy => information asymmetries)  Opportunism is then is the main concern in any agency relationship, because it causes transaction costs to raise;  «Transaction costs» within the agency relationship are called «agency costs»; thus agency costs could be thought as a «species» of the larger category of the «transaction costs» IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE «AGENCY PROBLEM» CAUSES «AGENCY COSTS»  The delegation of decision-making authority from the principal to the agent is problematic in that: 1.The interests of principals and their respective agents will always diverge to some extent; 2.The principal cannot perfectly and costlessly monitor the actions of the agent; 3.The principal cannot perfectly and costlessly acquire the information available to or possessed by the agent; 4.The agent cannot perfectly and costlessly reassure the principal about her skills, experience, diligence, and trustworthiness (loyalty); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «AGENCY COSTS» DEFINED  Types of “agency costs” (according to Jensen & Meckling): 1. Monitoring costs: expenditures incurred by principals in monitoring agents’ actions; 2. Bonding costs expenditures incurred by agents in order to reassure principals (may include costs incurred by prospective agents in order te be retained by principals): they may result in a reduction in monitoring costs; 3. Residual loss typically borne by the principals (almost inevitable in any transaction; cannot be eliminated, it may be only reduced); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved AGENCY THEORY AND THE CORPORATION: WHERE ARE WE LIKELY TO FIND «OPPORTUNISTIC BEHAVIORS» there are 3 major “places” for agency costs to rise, in connection with opportunistic behaviors within the corporate framework: A) Situations of conflicts between shareholders, as a group, and directors (management, generally) of the “public company” (=> delegated management) B) Situations of conflicts among shareholders (majority vs. minority shareholders, especially in “closely-held companies” and within group of companies); C) Situations of conflicts between shareholders (especially ma- jority shareholder(s)) and other constituencies (stakeholders) of the corporation (e.g.: corporate creditors, employees, suppliers); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  IBCL/CL2 A.Y. 2023-2024 (2 ND SEMESTER) The corporation as a form of business (PROF. MAURIZIO organization: BIANCHINI) The origin of the main «Agency problem» (and the higher source of «Agency costs») within the incorporated firms: the Berle and Means PART I, theory of the «divorce» of property (of the UNIT I, company’s assets) from «control» (over the business operations) SECTION 4.C  THE COMPANY’S MOST IMPORTANT «LEIT MOTIV»: THE PROBLEMS OF «GOVERNANCE» AS PROBLEMS OF «AGENCY»  A major intellectual theme in the study of the modem corporation is the "separation of ownership and control" thesis, which was first popularized by Adolf A. Berle and Gardiner C. Means, in 1932 in their famous book “The Modern Corporation and Private Property”; o The basic idea that inspired Berle & Means pioneering work is that dispersed “owners” (shareholders) of the modem corporation do not have a sufficient economic incentive to effectively control corporate management (directors and officers) and, consequen- tly, that managers –knowing it–often act in their own interests rather than in the stockholders' interests => conflict of interests; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE «DIVORCE» OF PROPERT Y FROM CONTROL OCCURRING IN (LARGE) INCORPORATED FIRMS («PUBLICLY-HELD CORPORATIONS») «the typical business unit of the 19th century» (owned by individuals or small groups, in charge of the firm’s direct management) is contrasted to «great aggregations in which tens and even hundreds of millions of dollars, belonging to tens or even hundreds of thousands of individuals, are combined through the corporate mechanism into a single producing organization under unified control and management»; Example: American Telephone & Telegraph Company («AT&T»): Assets of almost 5 billions of dollars; Over 454.000 employees; 567.694 shareholders. (Berle and Means, The Modern Corporation and Private Proper ty, 1932, Ch. 1 «Property in Transition, p. 4) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE «DIVORCE» OF PROPERT Y FROM CONTROL OCCURRING IN (LARGE) INCORPORATED FIRMS («PUBLICLY-HELD CORPORATIONS») «such an organization of economic activity rests upon two developments each of which has made possible an extension of the area under unified control»; 1.«[t]he factory system, the basis of industrial revolution, brought an increasingly number of workers directly under a single management» 2.«[t]hen the modern corporation, equally revolutionary in its effects, placed the wealth of innumerable individuals under the same central control» (Berle and Means, The Modern Corporation and Private Property, 1932, Ch. 1 «Property in Transition, p. 5) We may add a third element => the issuance of company’s stocks to the “public”, and the stock trading in the securities markets; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE «DIVORCE» OF PROPERT Y FROM CONTROL OCCURRING IN (LARGE) INCORPORATED FIRMS («PUBLICLY-HELD CORPORATIONS») «by each of these [three] changes the power of those in control was immensely enlarged and the status of those involved, worker or property [i.e., capital] owner, was radically changed» 1. «The independent worker who entered the factory became a waged laborer, surrendering the direction of his labor to his industrial master» 2. «The property owner, who invests in a modern corporation so far surrenders his wealth to those in control of the corporation that he has exchanged the position of independent owner for one in which he may become merely recipient of the wages of capital» (Berle and Means, The Modern Corporation and Private Property, 1932, Ch. 1 «Property in Transition, p. 5) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE «DIVORCE» OF PROPERT Y FROM CONTROL OCCURRING IN (LARGE) INCORPORATED FIRMS («PUBLICLY-HELD CORPORATIONS») “Corporations have ceased to be merely legal devices through which the private business transactions of individual may be carried on. […] The corporations has, in fact, become both a method of property tenure and a means of organizing economic life» «In its new aspect the corporation is a means whereby the wealth of innumerable individuals has been concentrated into huge aggregates and whereby control over this wealth has been surrendered to a unified direction […]. The surrender of control over their wealth by investors has effectively broken the old property relationships and has raised the problem of defining these relationships anew» «The direction of industry by persons other than those who have ventured their wealth has raised the question of the motive force back of such direction and the effective distribution of the returns from business enterprise» (Berle and Means, The Modern Corporation and Private Property, 1932, Ch. 1 «Property in Transition, p. 3 and p. 4) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE «DIVORCE» OF PROPERT Y FROM CONTROL OCCURRING IN (LARGE) INCORPORATED FIRMS («PUBLICLY-HELD CORPORATIONS») Berle & Means theory explains that the «corporate system appears only when this type of private or ‘close’ corporation has given way to an essentially different form, the quasi public corporation» (Note: in today’s lingo: “public” or “publicly held” corporation or company)  i.e., “a corporation in which a large measure of separation of ownership and control has taken place through the multiplication of owners” (Berle and Means, The Modern Corporation and Private Property, 1932, Ch. 1, p.5) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE DIFFERENT DEGREES OF THE «DIVORCE» OF PROPERT Y FROM CONTROL IN INCORPORATED FIRMS However, B&M pointed out that “[s]uch separation may exist in varying degrees”: A. Majority shareholders vs. minority shareholders: “where the men ultimately responsible for running the corporation own a majority of the voting stock while the remainder is widely diffused, control and part ownership are in their hands” In these cases, “only for the remaining owners is there separation [of ownership] from control” (Berle and Means, The Modern Corporation and Private Property, 1932, Ch. 1 «Property in Transition, p. 5-6) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE DIFFERENT DEGREES OF THE «DIVORCE» OF PROPERT Y FROM CONTROL IN INCORPORATED FIRMS (continued)B&M pointed out that “[s]uch separation may exist in varying degrees”: B. “frequently, however, ownership is so widely scattered that working control can be maintained with but a minority interest. The Rockefeller family, for example, is reported to have retained direct or indirect minority interests in many of the Standard Oil Companies; and in the case of the Standard Oil Company of Indiana, this interest, amounting to only 14,5%, combined with the strategic position of its holders, has proved sufficient for the control of the corporation” “In such a case the greater bulk of ownership is virtually without [i.e. deprived of corresponding right of] control” (Berle and Means, The Modern Corporation and Private Property, 1932, Ch. 1 «Property in Transition, p. 6) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE DIFFERENT DEGREES OF THE «DIVORCE» OF PROPERT Y FROM CONTROL IN INCORPORATED FIRMS (continued) B&M pointed out that “[s]uch separation may exist in varying degrees”: C. “Separation of ownership and control becomes almost complete when not even a substantial minority interests exists, as in the American Telephone and Telegraph Company, whose larger holder is reported to own less than one per cent of the company’s stock. “ “Under such conditions control may be held by the directors or titular managers who can employ the proxy machinery to become a self-perpetuating body [so called “self- entrenchment”], even though as a group they own but a small fraction of the stock outstanding”; (Berle and Means, The Modern Corporation and Private Property, 1932, Ch. 1 «Property in Transition, p. 6) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE DIFFERENT DEGREES OF THE «DIVORCE» OF PROPERT Y FROM CONTROL IN INCORPORATED FIRMS (continued)B&M pointed out that “[s]uch separation may exist in varying degrees”: “In each of these types, majority control, minority control, and manage- ment control, the separation of ownership from control has become ef-fective – a large body of security holders has been created who exercise virtually no control over the wealth which they or they prede- cessors in interest have contributed to the enterprise” [= equity capital]; “In the case of management control, the ownership interest held by the controlling group amount to but a very small fraction of the total ownership”. “Corporations where this separation has become an important factor may be classed as quasi-public in character in contradistinction to the private, or closely held corporation in which no important separation of ownership and control has taken place”; (Berle and Means, The Modern Corporation and Private Property, 1932, Ch. 1 «Property in Transition, p. 6) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE «DIVORCE» OF PROPERT Y FROM CONTROL OCCURRING IN (LARGE) INCORPORATED FIRMS («PUBLICLY-HELD CORPORATIONS»)  “collective action problem” => “rational apathy” of “de minimis shareholders”, as a group (“collectively”) => each group’s member lack sufficient economic incentives to invest time and skills to monitor effectively what the company’s management is doing;  The basic notion of Berle and Means 1932 theory of "separation of ownership and control" is that (1) each dispersed owner of the public corporations (i.e., each of the scattered, de minimis shareholders of listed companies, owns just a bunch of vo- ting shares corresponding to a very small fraction of the total equity value of the bu- siness venture) does not have sufficient economic incentives (no time, no adequa- te skills, no sufficient experience, etc.) to effectively control (monitor) corporate ma- nagement – i.e., company’s directors and officers; and (2) that managers – knowing that asymmetry of information with their “principals” would protect them from sha- reholders’ effective monitoring (and, thus, from management liability), often are tempted to manage the company’s assets “opportunistically” (in their own inte- rests), rather than in the stockholders’ exclusive interests => conflict of interests! IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  The advent of “Managerial Capitalism” and the “divorce” of “property” from “control” Publicly-Held Companies Dispersed Shareholders (widely dispersed [“principals” / electorate] «ownership» model) Separation between «property» Delegation of «control» power ….separation between and «control» (Berle&Means, 1932): over the firm’s assets, from «property» and «control» shareholders to directors and (Berle & Means 1932) Agency Type of Shareholders are too many and each topmanagement…. Relationship/1 ©Maurizio Bianchini 2024 – All Rights Reserved holds such a small economic stake in the large companies’ equity capital that it is no longer economically sound for them (as «rational market agents») to manage directly the business, nor Board of Directors [“agents”/legislative organ] to effectively monitor their agents: while shareholders still «own» the company, they do not (they cannot) Agency-Type of longer «control» how it is managed! Relationship/2 Management feels unrestricted in Top Management (Officers) managing the company’s business: an [firm’s bureaucracy /executives] «agency problem» inevitably arises; (more agents) IBCL/CL2 A.Y. 2023-2024 67  US Publicly-Held Companies (widely dispersed «ownership» model) Dispersed Shareholders [“principals” / electorate] Delegation of control power ….separation between over the firm’s assets, from «property» and shareholders to directors «control» (Berle & and top management…. Means 1932) ©Maurizio Bianchini 2024 – All Rights Reserved “Theory of the Firm”/ Board of Directors “Agency Theory” Michael Jensen [“agents”/legislative organ] US economist (1939-) “The Little Republic” Taking up ideas from William Blackstone Berle&Means, Coase, English jurist (1723–80) Williamson and others, he and Meckling, in 1976, set He analogized the company forth the “Agency Costs” Top-ranking Officers governance to a government theory and the first “Nexus of system: electorate (people) => Contracts Theory”: the so [firm’s bureaucracy /executives] legislative power (Parliament) => called “contractarian” theory (more agents) government (executive power) of the modern company IBCL/CL2 A.Y. 2023-2024  IBCL/CL2 A.Y. 2023-2024 (2 ND SEMESTER) The corporation as a form of business (PROF. MAURIZIO organization: BIANCHINI) the main characterstics of the very peculiar PART I, type of contract used to form a company (or, which is the same, used to incorporate UNIT I, a «firm») SECTION 4.D  THE COMPANY CONTRACT business organizations, and namely companies, although they are “living” organization (they operates in the markets for usually with a long-term perspective), are typically originated (created) by specific kinds of contracts: o These contracts are usually Multi-party = even if only one party establishes the company by a unilateral act, the “contractual” nature makes the company “open” to subsequent “adhesion(s)” to the company venture by an undefi-nite number of persons (Note that these persons, in turn, maybe either natural persons or “legal” persons); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE COMPANY CONTRACT o (continued) These contracts are usually Associatory contracts = each thereto take the same position of the other parties vis-à-vis a «joint purpose» of the contract; Associatory contracts are usually considered cooperative types of contracts, because each party thereto shares the same purpose with each of the other parties, and all parties both: (i) may have economic reasons to cooperate together in pursuing such common purpose (even if, in practice, they do not cooperate), and (ii) shall cooperate according to “procedural” mechanisms provided by the contract (and/or by the law) in order to make them taking decisions on some (or all) the issues relating to the pursuing of the contract purposes; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE CORPORATE CONTRACT o (cont.d) These contracts are usually qualified as: Long-term => characterized by “bounded rationality” (limited ability to deal with future events); exposed to uncertainty of future events; exposed to opportunism ex post (upon unforeseen change(s) of circumstances that may expose one party to the opportunism fo the other party); Relational => cooperative (identity of parties is re-levant), usually involving some degree of asset (capital and/or labor) specificity (“idiosyncratic” type of investment) and often exposed to ex ante and/or ex post opportunism (Williamson) o thus, these contracts are deemed to be incomplete (Williamson); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE COMPANY’S CONTRACT the contract itself is also qualified «organizational», i.e., it serves as a set of rules intended to create and govern the voluntary organization of a different clusters of persons (with different economic interests and goals), labor and assets – labor and capital – thereby (at the same time) organizing those factors of production along the contract’s duration; o The organization of the production factors is made possible: (a) by a system of both legal and contract rules allocating power/ authority and responsibilities among the corporate «actors» (shareholders, board of directors, managers, auditors, ecc.) with respect to the production factors, and (b) by setting up legal «procedures» that will allow these groups to adopt binding decisions, thereby causing the organization to «act» in the market (market agent), as if it were a «person» (“legal person”); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  THE COMPANY’S CONTRACT in order for those kind of (multiparty+ associative+ long- term+relational+organizational) contracts to work….. …there must be some (set of) terms, conditions and/or clauses that shall provide for the «governance» of the multiple groups of parties involved in the «organization» the contract establishes at law (and by the operation of [company] law), so that the purpose(s) and the equilibrium of the contract could be preserved during its entire “life” (contract’s long-term feature); Usually these set of governance (organizational) rules are: o Legal rules , including mandatory rules (e.g. providing for “fiduciary duties”, which, in turn, are derived from agency law) o Highly standardized (“plain vanilla”) contractual rules (company’s articles of incorporation and by-laws), in publicly-held companies; o Specific contractual rules, “tailored” on the circumstances and on the members’ specific needs, in closely-held corpoations and in LLCs; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  IBCL/CL2 A.Y. 2023-2024 (2 ND SEMESTER) (PROF. MAURIZIO BIANCHINI) The corporation as a form of PART I, business organization: UNIT 1, closing remarks SECTION 5  UNIT 1 CLOSING REMARKS: ENTERPRISE FREEDOM – FREEDOM TO INCORPORATE A BUSINESS FIRM The legal system provides for a wide scope of private ordering “tools” a private person can choose from in order to set up a business organization, a firm (“enterprise” or “undertaking”); Among the business organization forms there is the company, the most common “vehicle” to carry out a business or trade for profit; freedom of incorporation = choosing where, when, how to incorporate, and, to a great extent, the terms upon which the company shall be structured, financed, managed and the shareholders’ rights allocated; Companies are governed by both, legal rules and private rules (contract- based rules): the contractarian theory of the company cannot wipe-off the role of the law (company law rules) enabling the company formation via the execution of a (very specific type of) contract (“articles of incorporation” with an annexed set of “by-laws”) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  UNIT 1 CLOSING REMARKS: «TWO WAYS TO DEFINE A COMPANY» 1. “An organization of the factors of production (a firm) engaged in a trade or business in the market”  Company is a way to organize firms  stress is on “organization”, and on its immediate purpose (carrying out businesses in the market);  company as a “market agent”: operates in the market place;  but still very broad; IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «TWO WAYS TO DEFINE A COMPANY» 2. “as a distinct legal entity … endowed by government with certain collective rights and responsibilities”  “so distinct, in fact, that its shareholders can sue it”  a legal entity that is “not condemned to die of old age and can create a progeny at will” (Micklewait&Wooldridge, 2003) IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «TWO WAYS TO DEFINE A COMPANY» 2. (continued) “as a distinct legal entity … endowed by government with certain collective rights and responsibilities”  an “artificial being” (“persona ficta”) that (usually) created by the State, that affords the privilege of the LL to its members (shareholders, quota-holders);  with other typical, common characteristics, such as:  centralized management;  free transferability of the shares (or quotas);  ownership-type of rights (but not traditional “ownership rights) entrusted with the equity investors [=> you should know the difference between equity and debt investment!] IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «TWO WAYS TO DEFINE A COMPANY» 2. (continued) “as a distinct legal entity … endowed by government with certain collective rights and responsibilities”  are intended as “artificial persons”, with many of the “features” (rights and liabilities) of a biological person (“natural person”):  the same ability to do business as a real person, legally binding the assets committed to the company to its liabilities: i.e., to the obligations undertaken by its lawful agents (those entrusted with the authority to contract with third parties on behalf of the company => company’s representatives); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «TWO WAYS TO DEFINE A COMPANY» 2. (continued) “as a distinct legal entity … endowed by government with certain collective rights and responsibilities”  They have their own “reputation” and “name” (not just trade name) protection;  Name protection (besides IP right over the “brands”)  “Libel and Slander” protection;  To some extent, they may become political actors (they may endorse politicians, political parties, they can make (and deduct from taxes) donations, charity, etc. IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  «TWO WAYS TO DEFINE A COMPANY» 2. (continued) “as a distinct legal entity … endowed by government with certain collective rights and responsibilities”  Taking up from such “anthropological” posture of the companies/corporations, during the late XIX Century/beginning of the XXth Century, there have been intense legal discussions on the very nature of the modern corporation, confronting three main legal entity theories;  But now, let’s step back to a historical sketch of the “Modern Corporation” (or “Company”); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved  UNIT 1: CLOSING REMARKS In sum, the company, is a sophisticated form of business organization for the coordination of labor and capital, intended to carry out one or more trades or businesses (company as a business vehicle); A company could be thought as an “incorporated” firm, based on (created upon) a voluntary agreement, the corporation (or company) contract; Within this (contractual-based) business organization, one could find several contractual and quasi-contractual relationships (long-term, relational-type of contracts, whose private rules are deemed incomplete); These relationships can be construed as “agency relationships” (again: “agency” is thought as a sort of “modular unit” for larger and more sophisticated types of business organizations); thus, with companies we also get to deal with “agency problems” (“agency costs”); IBCL/CL2 A.Y. 2023-2024 ©Maurizio Bianchini 2024 – All Rights Reserved