Corporate Law's Limits

Abstract

A strong theory has emerged that the quality of corporate law primarily determines whether ownership and control separate, particularly to the extent law stymies controllers' self-dealing transactions that damage minority stockholders. But in several rich nations, shareholders seem satisfactorily protected, but separation is narrow. Something else has impeded separation. Separation should be narrow if shareholders face very high managerial agency costs if ownership diffused. But these agency costs are not corporate law's focus. Judicial doctrine attacks self-dealing, not business decisions that are bad for stockholders. Indeed, the business judgment rule puts beyond direct legal inquiry most key agency costs - such as over-expansion, over-investment, and reluctance to take on profitable but uncomfortable risks. Thus, even if a nation's core corporate law is 'perfect,' it directly eliminates self-dealing, not most managerial mistake or most misalignment with shareholders. If the risk of managerial misalignment varies widely from nation-to-nation, or from firm-to-firm, ownership structure should also vary widely, even if conventional corporate law tightly protected shareholders everywhere from insider machinations. I show why this variation in managerial alignment is likely to have been deep.