Professor Griffith, many law students will not go on to practice corporate law. Should the average student bother taking a corporate law class? Will they learn anything that could help them be better lawyers in other areas? Well, I think corporate law is really a foundational course. At Fordham it's required, but my view would be that at every other place it should be. If you think about the questions, the fundamental questions that we're asking in corporate law, what we're really asking is who decides and subject to what kinds of constraints. Now, those fundamental questions, who decides and subject to what constraints are really the basis of another major class that everyone takes, and that's constitutional law. And the way that I like to think about it is that corporations is the other side of the ledger. It's the private side of the ledger from the public side of con law and corporate law asks really the same questions who decides in an organization and subject to what kinds of constraints. I think students come to corporate law with a bunch of preconceptions, and some of them are not true. For example, that it's very mathy or that it's dull and business is really terrible and boring. I don't think any of that's true. What I'm trying to do in the corporation class is teach students to think, not so much like lawyers, although that's ultimately what we're going to be doing. But if the first year is about teaching students to think like lawyers, in the corporations class, we're trying to get them to think a little bit like business people. So what does it mean to think like a business person? And my children joke that it means wearing a tie and talking about charts, but that's not what it is. There are really sort of three ideas that I try to pitch to my students to work on when we approach the cases in corporate law. And to think about three ideas in every case to try to situate the case in a business context, and those ideas are incentives, institutions, and information. We try to come into the corporate law cases, thinking about what are the parties incentives. Now everyone has incentives. But the real assumption that we start with there is that people are neither angels nor beasts. Not everyone is all good or all bad, no one is, but instead people mostly respond to incentives. And what that means is if you pay for something, you get more of it. Or if you take money away for something else, you get less of that. And that leads to an ability to predict behavior on a large scale. The other idea there is institutions, which is to say entities or things. What is the thingness of the institution that we're studying, whether it's a partnership or a corporation, how does it work? What is its internal structure and what are its internal dynamics? We focus on the institution of the corporation. And then the last thing that I think it's important to mention is information. When we talk about information in organizations or information in society, the question is where is the information and how can we get it in the hands of the people that need it or that need to make use of it? A very good example of the information problem is the famous critique of socialism. The socialist knowledge critique is that in order to make decisions about what to make or what to do in a society, the decision maker needs to know about the preferences of the people that are going to make use of the product. The trouble is that the knowledge about the preferences of the people that are going to make use of the product is at the low level, the consumer level. Up at the top central planner level, which is how obviously a socialist economy works, that information isn't present. And so one of the reasons that socialism breaks down is that it's difficult to get that knowledge that is in the hand of the consumers, up to the hand of the central decision maker without some kind of market structure. So one way to think about what corporate lawyers do is, well, of course there are litigators who work in the corporate law area and litigate corporate law cases. And that's true. And of course there are lawyers who do regulatory work or compliance work for operations. That's also true. But I think the way to think about what the most interesting corporate work is there's a phrase: transaction cost engineer. Businesses want to do things. And there is a way to do things. There is always a way to do things, but sometimes it takes a smart person to figure out how to make that happen, given the set of constraints, the environment of constraint that that business operates in. Those constraints can be legal, they can be regulatory, they can be constraints on the product market or the competition situation that the business finds itself in. But the lawyers, good lawyers, good corporate lawyers are the ones who are able to figure out how to navigate through those constraints and design transaction structures or deals for the business that make the most sense for that firm. Before you teach about corporate transactions, you must start with some basic principles about the structure of corporations themselves. “Institution” was one of the key principles you mentioned. What makes an institution a corporation? When we think about what a corporation is, it's important to remember that we're describing a thing that's evolution is ongoing. Any one particular corporation will be in a particular phase of its evolution. And then the corporate form itself is probably undergoing evolution. So when we ask what a corporation is, we have to keep in mind that there are many answers to this question and not just one. For example, if you think about a big publicly traded corporation, the kind that you would have by be able to buy shares of in the New York Stock Exchange, you're going to have one idea about what it is. It's big, it's monolithic, it has a lot of power and a lot of control. If that's your model for what a corporation is, that's very different from the corporation that you and I might form to engage in some small business in our community. So if you think about the kind of big corporations that do things, that we think are wrong, if you have the sort of occupy Wall Street conception of what a corporation is, your starting point might be to want to fix the corporation, to try to come into the corporation from the outside and regulate what it is. But if your starting point is different from that, if your starting point is a bunch of individuals coming together to try to make or do something, your starting point might be different. For example, if you and I are going to go into business and we need capital, well, we're going to have to make the kind of arrangements between ourselves and between our investors that are desirable to our investors. If we want to hire employees, we're going have to make the kinds of arrangements that are desirable to our employees in order to get them to work for us. If we want to ultimately sell products, we have to make products, of course, that are desirable to the consumers. It's important to remember that corporations exist in a nexus of constraints. Those constraints are mostly imposed upon them by the markets in which they operate. The capital market first and foremost, the labor market for employees and the product market for the things that they make and do. The corporations that we see in the world today are responsive to all of those market constraints. And so it's important to think of them as from the beginning, rather than thinking of them at the end, as this machine, as this animal that we have to control. So let's think about corporations as the answer to a problem. What's the problem? The problem is not bigness or regulation. The problem is we want to make or do something. So there's a product that we have or that we have the idea for, that we need capital to create. Many corporate law cases involve the clash between the money person and the idea person. So let's say that we have an idea for a business or an idea for a product that fills a niche and that basically solves a problem that exists in the world today. Well, in order to make that product, we need capital. We're going to need to find the money to build the factory, to make the thing that we have the idea to make, that we need to go out and appeal to investors to do that. So once we think about the firm, as the solution to a problem, then we can ask why is the a corporation? And the answer is it usually doesn't start that way. It usually starts as a couple of people in their garage in the famous case of Silicon Valley or wherever. And at some point they need to organize their business as a firm. But it's not necessary to organize businesses as corporations, many business to start out as partnerships, which is one type of organizational form. Other businesses might start out as LLCs or limited liability companies. And these are just different forms of coming together to do business that have different sorts of attributes. The corporation is just one kind of a solution to the problem. The different entity forms that there are, are different kinds of solutions to the problem. And I think that it's important to think about entrepreneurs and capitalists as trying to solve the problem as efficiently as they can. Again, that's where lawyers come in. The transaction cost engineer, what's the best organizational form for this business at this point in its life. hat do the different types of corporations have in common? Well traditionally we would say that there are five aspects of the corporation. Limited liability, legal personhood, the separation of ownership and control and free transferability of shares, and finally a flexible capital structure. For limited liability, we just mean that the investors in the corporation are not liable beyond the amount of their investment for the liabilities generated by the corporation itself. Again, the remains liable for its liabilities, the liabilities that it generates, but the individual investors liability is limited by the amount of their investment. By legal personhood, we mean that corporations themselves can make contracts, can buy and sell things and own things themselves as opposed to only being able to own things through the partnership or the people... In a partnership, technically the partners own everything in common. In a corporation, the corporation owns the assets of the corporation. Separation of ownership and control just means that the people that own the corporation are not the people that run it. The owners are the shareholders or the investors and the people that run it are their managers, starting with the board of directors and then any other managers that the board of directors might appoint. The fundamental agency cost problem of the corporation occurs because of the separation of ownership and control. But it's important to keep in mind that the separation of ownership and control is itself the solution to a problem. To see that, you have to imagine a capital intensive business like railroads. To build railroads from the East Coast to the West Coast needed piles and piles of money. Not only because railroads are expensive to build, but also because railroads generate lots of liabilities, they run over cows and people and the trains burn down corn fields on the way across the country. That's a capital intensive business. In order to make that business work, you have to raise money from lots and lots of people. If all of those people have a hand in the control of the business, it's going to be pretty hard to get things done. Anyone who's ever tried to run things through a committee knows that that's the case. So the separation of ownership control solves the problem of having too many fingers in the pot, but it creates the problem of agency costs between the owners and the managers. The fourth attribute of corporations is the free transferability of shares. This means that corporation shares can be bought and sold by anybody, from anybody that has them and the corporation, unlike a partnership, doesn't fundamentally change as the result of the deletion or the addition of somebody new in the ownership structure. A partnership really is the collection of the partners together. A partnership really changes when one of the partners goes out and another partner comes in. A corporation isn't like that. A corporation is a thing unto itself. And when new shareholders come on board or other shareholders leave, the corporation continues to exist in really unaltered form. And finally flexible capital structure. Corporations can issue debt and equity securities. And they can issue them anytime they want subject to whatever kinds of problems that they have. So you can imagine a corporation that's just going public for the first time, thinks that it's going to do spectacularly and is able to issue plain vanilla, common stock, where there are no special rights to people that are buying that class of shares. Time goes on, the corporation does less well. And maybe what the corporation needs to do now is get a new round of capital in from equity investors. But if the corporation is doing less well, those investors might want special rights like protection in bankruptcy, above the common shareholders. They might want a higher fixed dividend than the common shareholders. And because the corporation needs their capital, the corporation would be in a position to make deals to them at the time that it is issuing those shares. So the corporation has a flexible capital structure to allow it to make deals that it needs to make at different times to raise capital as time moves on. Can you talk more about the capital structure of a corporation? Who controls the money since the owners provide the funding but the managers make the day-to-day financial decisions? So the structure of a corporation really is that you have the shareholders, those are the owners, those are equity investors. So equity investors means, they're not debt investors, that means they have a residual claim. The residual, just as the word implies, is what's left over after everyone else gets paid. So a residual claimant is the last person to get paid. He or she gets what's left over. Who gets paid first? Answer, the fixed claimants. Who are the fixed claimants? People that have a fixed contract claim against the firm, those would include, for example, employees who have a salary, whose salary is paid every month. Their claim gets paid before the residual. Your profit only comes after all of these costs, which are fixed claims, are paid off. Who else has a fixed claim? A creditor, who gets paid a certain amount of interest, a supplier, who has to be paid for the things that they sell into the firm. All of the fixed claimants, who are contractual, get paid first. And then what's leftover is the residual. It's the residual, that is the shareholder, that's the ownership interest. There's something special about the residual claim that is what leads to the principle of shareholder wealth maximization. And the idea is that the firm should be run for the residual claimant. So the shareholders of their residual interest, owners. And then, who runs the firm answer the board of directors. So the corporate structure, in Delaware, this is section 141-A, of the corporate law that says, "The business and affairs of the corporation shall be run at the direction of a board of directors." What is a board of directors? It's a group of people who are elected on a regular basis, usually an annual basis, by the body of shareholders. What are the boards powers? The boards powers are everything to run the corporation. What are the shareholders powers? The shareholders powers are very few and limited. Their principle shareholder power is to elect the board of directors. And that's it. There are certain things that shareholders get approval rights of, but shareholders don't get to put agenda items in front of the corporation. The first actor always is the board and the most that shareholders might get is an approval right. For example, in a merger or acquisition setting, shareholders get approval rights. But the most important shareholder right, is the election of the directors. Now what do the directors do? In a small corporation, the directors might run it. They might do everything. But in a very large corporation, the corporations that we see on the New York Stock Exchange and so on, the most important role of the board of directors is to hire the CEO. Who is the CEO? The CEO may often be on the board, but that's a second role that the CEO would have. The CEO is a manager. The CEO is an employee. The CEO is an employee of the corporation. The board members are not employees, they are fiduciaries. That means that they are like trustees in a role where their job is to look out for the benefit of somebody else, namely the shareholders. What they do is hire the managers to run the company and make all the sort of business decisions for the firm. Those managers are the CEO, other C-suite officers, like the chief financial officer or the chief operations officer. Sometimes corporate law professors, like myself, blend the distinction between the board of directors and people like CEOs and we refer to all of these people as managers. This is because their interests are very close to each other. They're all sort of an intermediary class of managers who run the business for somebody else. There are legal differences that are important. CEOs are agents. The CFOs are agents of the corporation. Directors are not technically agents of the firm. They're not employees. They're something else, they're trustees. But those legal differences actually fade when we're just talking about the big picture agency problem. The agency problem being, are these people actually accountable to the people who are supposed to be in charge, namely the shareholders? So it's not unusual for a corporate law professor to elide the difference between managers and directors, because they both stand in this intermediary managerial role, but there are important legal differences between the two. What makes a corporation a legal entity? Well, I think it's important to remember that corporations are limited liability entities. And so in order to get recognition as a limited liability entity, you have to file a piece of paper with the secretary of state, some place. This is true for corporations. It's true for LLCs. It's true for limited partnerships and limited liability partnerships. You have to be organized somewhere and you have to file a piece of paper that says you are a limited liability entity. Those filings serve notice purposes so that the counterparties in contract understand that they're dealing with an entity that's a limited liability entity. Why does that matter to them? It might matter to them because they might want to not deal with a limited liability entity or more likely they'll want to do things in the contract to take account for the fact that they only have a limited recall to pursue if there is a breach. So to be legally recognized it has to be filed. But it's important not to overemphasize the importance of file filing in a state. States don't create corporations. People create corporations. Corporations are the result of spontaneous order. People come together to form a business, to do something and they need to organize it someplace. So what the state does is give them a place to file a piece of paper. And another way to think about this is it's not just a piece of paper, but what you're doing when you file the piece of paper is accepting the default rule of law that that state provides in its corporate law. But corporate law is very flexible. Corporations and their bylaws and their charter documents can alter those rules with their investors almost entirely. There are very few corporate law rules that are not alterable. And so the ability to alter the corporate structure is extremely important. That's why it's important to think of the corporation not so much as a thing that exists under state law, as a thing that's created by the founding investors to do business. What the state law provides is an organizational form that is tailored to fit the business of the founding investors. One quick follow-up question - why do most corporations choose to file in Delaware? The largest corporations in America, something like 50% of the fortune 500, more than half of the corporations that trade on the New York stock exchange are organized in the tiny state of Delaware. And you might ask yourself the question of why that is. And that's a good question, but let me give a history of it. First, before there was Delaware, there was New Jersey and most American corporations were organized in New Jersey. And what New Jersey provided was a very simple corporate law statute. There weren't a lot of mandatory terms corporations could adopt freely improvise on the terms that the New Jersey statute offered. And there were a few other states, they were competing for corporate law business at the time that New Jersey was, but New Jersey was a perfect location. Right across the river, either from Philadelphia or New York, which is where a lot of American business was. And again, the New Jersey corporate law at that time was very flexible, permissive. Businesses could do what they wanted to do until New Jersey had a governor named Woodrow Wilson. And what Woodrow Wilson's idea was was that there were certain kinds of things that he couldn't tolerate New Jersey businesses allowing. And those things were mainly related to what we now think of as antitrust. So corporations owning other corporations for example, was a no-no. So what New Jersey did was pass a series of laws. I believe they were called the seven sisters, which regulated corporations to a very high degree, principally on issues related to antitrust. The result of that, a regulatory intervention in corporate law was that the largest corporations in America moved one state south to New Jersey. The result of that regulatory intervention was that corporations moved one state south out of New Jersey to the little tiny state of Delaware, much to my shame as a New Jersey tax payer today. I want to go back to what you said a few minutes ago about corporations being limited liability entities. What does that mean exactly and why is it necessary? Yeah. We can think about liabilities as just basic contract or tort liabilities. So a breached contract creates a contractual liability. The inability to pay your employees creates a contractual liability. And then tort liabilities are running somebody over or blowing somebody up. The kinds of liabilities that are created in tort. All of those liabilities come into the corporation and that's where they stop in the case of limited liability. So limited liability, it's important to remember, is not limited liability for the corporation. It's limited liability for the investors. That means if you or I invest a thousand dollars or $10,000 in a corporation that does something terrible, that creates a $10 million loss, the corporation is still liable for that $10 million loss. The corporation's liability is not limited for whatever it does as a tort visa or in contract. The corporation remains liable. But you and I, as investors in the corporation, our liability is limited by the amount of our investment. Well, what's fun about limited liability is that it doesn't apply to everyone who is part of the business. So there are some businesses, for example, medical practices might organize as LLCs. So imagine a doctor that organizes his or her practice as an LLC. That means that the doctor's phone bill and lease probably are billed to the LLC. And so if there's a default on the lease or the phone bill can't be paid, the phone come company has recourse only to the LLC and not to the owner who is the doctor. But if the doctor commits malpractice, if the doctor hurts someone in the course of operating on them, that person has liability against the doctor as an agent of the business as the tort visa. So the other thing that limited liability doesn't do is remove liability from the tort visa. The thing that harms the person, the entity, or the person that harms the person retains liability as the person that harms the person. So law firms are usually organized in that way to avoid the malpractice liability of each of their partners. Different states provide different kinds of solutions for different kinds of businesses. So accounting partnerships and law partnerships where individual partners might expose their other partners to malpractice liability, can organize in different forms that might help shield other of their partners from other partner malpractice. And some of them, there are these PCs, professional corporate. So what they try to do is shield the individual partners from each other and that's an important, for certain kinds of businesses, an important kind of liability shield. Limited liability obviously plays an important role if a corporation gets sued by a third party. What happens if the corporation is sued by someone who has a stake in the business? There are two kinds of suits that you can imagine. So one would be an outside claimant suing the corporation for a tort or a contract and that's just what we've thought about before. When someone from the outside sues the corporation, the corporation is liable, the business entity is liable. And the corporation satisfies that judgment, unless and until it goes bankrupt. In which case, that's the end of it because of limited liability. Very often the board or the CEO will get named in that suit as well, but they'll be covered. Their liability won't be personal. Their liability will only be as agents of the corporation. But when the shareholders sue, this sort of becomes a more interesting question. When the shareholders sue the corporation, who are they suing? Well in corporate law, the shareholders are suing the board of directors, for breach of fiduciary duty. So a shareholder suit against the board of directors would claim, "That the board did not act carefully enough," that would be a breach of the duty of care, in other words, negligent. Or, "That the board of directors had a conflict of interest or that they were disloyal, that they breached the duty of loyalty." And so those two lawsuits have different probabilities of success. But essentially, it's the shareholders suing the board for some kind of breach of fiduciary duty. Now, often that breach will have been occasioned by the manager that's hired by the board. For example, the CEO will have done something really stupid. And the board of directors will have hired that CEO and not prevented that act from occurring. The shareholders will sue the board of directors and say, "Look, now you have to sue that CEO for all the bad stuff that the CEO did." This is a particular type of suit, called a derivative suit, where what the shareholders are really asking the board of directors to do something in litigation, which is to sue somebody else. And the way that the derivative suit works is, if the board of directors refuses, the shareholders have the chance to bring that suit anyway, subject to a certain number of conditions. It's a form of representative litigation where what the shareholders do is act as the corporation to try to acquit the corporations rights against some managers, some CEO type. There are a number of ways to end the derivative suit early. There are a number of requirements procedurally in bringing the derivative suit that helped the derivative suit to go away. But it's important to remember that what the derivative suit is fundamentally, is a form of representative litigation. These days, as lawyers, we all know the principle form of representative litigation is the class action. And the class action exists in the corporate context too. It exists in the corporate law contexts. So for example, when a corporation does a merger or an acquisition transaction, fiduciary duties are heightened at this moment. The duty of care, as we've discussed, doesn't operate as much of a constraint and is not much of a principle of judicial intervention. But the duty of loyalty has this sort of intermediate standard of review, in the context of mergers and acquisitions, and so this is a better claim from a plaintiff's perspective. Individual shareholders can bring class action litigation against the board of directors, for breach of fiduciary duty in the context of mergers and acquisitions transactions. And what are they saying? They're saying, "Well, the board didn't negotiate hard enough. They didn't get a big enough price for the sale of the company and they should have tried harder." These are class action claims that shareholders bring, again, against the board for breach of fiduciary duty. There's yet another form of shareholder litigation though, this is for mainly for public companies. For public companies they're subject also to securities litigation. Now securities litigation are brought by some investors, usually buyers or sellers, depending upon what the claim is, who bought or sold subject to some misinformation perpetrated by one of the corporation's managers on the public, like a misstatement, like, "Oh, we're doing great. We're doing great," but it turns out that the company is going out of business. In securities class action litigation, again, it's the shareholders, it's some of the shareholders, it's the ones who bought or sold during the time period of the fraud. And who are they suing? Well, they're suing the corporation itself and the managers who committed the fraud. And so this is a situation where shareholders are suing the corporation. But wait a minute, what does that mean? The shareholders own the corporation. The shareholders are the ones who are entitled to all corporate cash flows after the fixed claims paid. So what really is happening in securities litigation is shareholders suing themselves or some shareholders suing other shareholders. This is one of the basic critiques of securities class actions, in particular. There is a circular wealth transfer from the shareholders, back to shareholders, through the corporate form as a result of this litigation, but there is a tax in there, where the lawyers take a chunk. So imagine shareholder claimants, we say that, "There has been a securities misrepresentation that entitles us to relief." So the shareholders sue the corporation. If there is a settlement or a judgment, the corporation pays those shareholders for the fraud that was perpetrated, allegedly, upon them by the managers. But where does the money to pay that claim come from? It comes from the corporation, which is nothing but a pot of money owned by the shareholders. So this is the sort of circular wealth transfer from shareholders, back to shareholders, through securities litigation, with lawyers taking about 30 to 40% on the way out. When shareholders sue the board of directors, yes, they name the directors individually and directors can be personally liable. This is why boards of directors members always insist upon some kind of insurance in their professional capacity. And so there's a product called directors and officers liability insurance, where insurance companies actually foot the bill of most of this litigation. Now, of course, to say that an insurance company actually pays for it is only a partial answer, because the company pays the insurance company, the insurance premium. And insurance companies are in business to make money, so the insurance company doesn't suffer here. But the corporation pays for everything, but they just pay for it differently, by paying insurance premiums, ex ante. Thank you for listening to this episode of the No. 86 Lecture series on Corporate Law. The spirit of debate of our Founding Fathers animates all of the No. 86 content, encouraging discussion and critical reflection relative to how each subject is widely understood and taught in law schools and among law students. Subscribe to the No. 86 Lecture series on your favorite podcast platform to have each episode delivered the moment it’s released. You can also go to no86.fedsoc.org for lectures and videos on Federalism, Contracts, Jurisprudence and more. Thanks for listening. See you in class!