The Team Production Theory of Corporate Law: A Critical Assessment

Abstract

This article offers a critique of the production of corporate law as articulated by Margaret Blair and Lynn Stout and a partial defense of the shareholder primacy norm. The team production theory rejects the principal-agent model of the public corporation and replaces it with a approach to corporate governance. Under a mediating hierarch model, directors of public corporations do not maximize shareholder value but instead resolve competing claims that various stakeholders might have to the firm's residual product. According to Blair and Stout, this model of governance empowers public corporations to refrain from opportunistic exploitation of non-shareholder constituents and thus reduces the transaction costs associated with obtaining relationship-specific investment. Such a model supposedly illuminates numerous aspects of corporate law, particularly the law of Delaware, that the principal-agent model purportedly cannot explain. Blair and Stout limit their production to public corporations on the assumption that non-shareholder constituents of such firms are particularly vulnerable to opportunism. However, Blair and Stout have not shown that such participants in publicly-held corporations are more vulnerable to opportunism than similar participants in private firms. In fact, certain attributes of public corporations render participants in such ventures less vulnerable to opportunism than similar participants in private firms. Thus, the transaction costs of obtaining team-specific investment from non-shareholder constituents would seem to be lower for public corporations than for private firms, thereby undermining Blair and Stout's assertion that special economic characteristics of public firms call for a model of governance. At the same time, various facets of the public corporation, in particular the separation of ownership from control, render shareholders of such firms more vulnerable to opportunism than similar participants in private firms. If anything, then, the case for the shareholder primacy norm is stronger where public corporations are concerned. At any rate, Blair and Stout have neglected an additional consideration, namely, the costs of ownership. By transforming the firm's residual product into common property and empowering directors to distribute this property as they see fit, a mediating hierarch approach would undermine the shareholders' role as the primary monitors of firm activity and thus severely attenuate the incentives of directors to maximize anything other than their own welfare. As a result, such an approach to corporate governance would likely increase the transaction costs of inducing team-specific investment while at the same time attenuating the specialization benefits that would otherwise result from the separation of ownership from control. These ownership costs likely explain why, as Blair and Stout concede, states have rejected a mediating hierarch model for private firms. A fortiori, one would expect states to reject such an approach for public firms as well. Careful analysis of corporate law and the institutional arrangements that support it confirms that Delaware at least has embraced a principal-agent conception of the publicly-held corporation. Each of the doctrines that Blair and Stout have cited in support of their theory is perfectly consistent with the principal-agent model, particularly in light of the market mechanisms that have evolved to align the interests of shareholders and directors. The existence of these mechanisms, which supplement legal regulation of director conduct, would itself appear inconsistent with a mediating hierarch model of firm governance. Indeed, scholars who espouse the principal-agent view have applauded many of the attributes of corporate law that Blair and Stout have invoked. Moreover, Blair and Stout have overlooked other doctrines that are flatly inconsistent with a mediating hierarch approach and can only be explained by a principal-agent conception of the public corporation.