Agency Problems and Legal Strategies

Abstract

This article is the second chapter of a book authored by R. Kraakman, P. Davies, H. Hansmann, G. Hertig, K. Hopt, H. Kanda, and E. Rock, Anatomy of Corporate Law: A Comparative and Functional Approach, (Oxford University Press 2004). The book as a whole provides a functional analysis of corporate (or company) law in Europe, the U.S., and Japan. Its organization reflects the structure of corporate law across all jurisdictions, while individual chapters explore the diversity of jurisdictional approaches to the common problems of corporate law. Agency Problems and Legal Strategies establishes the analytical framework for the book as a whole. After further elaborating the agency problems that motivate corporate law, this chapter identifies five legal strategies that the law employs to address these problems. Describing these strategies allows us to more accurately map legal similarities and differences across jurisdictions. Some legal strategies are regulatory insofar as they directly constrain the actions of corporate actors: for example, a standard of behavior such as a director's duty of loyalty and care. Other legal strategies are governance-based insofar as they channel the distribution of power and payoffs within companies to reduce opportunism. For example, the law may accord direct decision rights to a vulnerable corporate constituency, as when it requires shareholder approval of mergers. Alternatively, the law may assign appointment rights over top managers to a vulnerable constituency, as when it accords shareholders - or in some jurisdictions, employees - the power to select corporate directors. Finally, the law may attempt to shape the incentives of managers or controlling shareholders, as when it regulates compensation or prescribes an equal treatment norm such as the rule that dividends must be paid out ratably. In addition to Chapter 2, Chapter 1 What is Corporate Law is available in full text on the SSRN at http://ssrn.com/abstract=568623. The abstracts for Chapter 3: The Basic Governance Structure; Chapter 4: Creditor protection (http://ssrn.com/abstract=568823); Chapter 5: Related Party Transactions; Chapter 6: Significant Corporate Actions; Chapter 7: Control Transactions; Chapter 8: Issuers and Investor Protection; Chapter 9: Beyond the Anatomy are also/will be available on the SSRN.