From Corporate Law to Corporate Governance

This essay is a contribution to the forthcoming Oxford University Press Handbook of Corporate Law and Governance edited by Jeffery Gordon and Georg Ringe. In the 1960s and 1970s, corporate law and finance scholars recognized that neither discipline was doing a very good job of explaining how corporations were really structured and performed. For legal scholars, Yale Law School professor and then Stanford Law School dean Bayless Manning confessed that corporate law has “nothing left but our great empty corporation statutes – towering skyscrapers of rusted girders, internally welded together and containing nothing but wind.” Michael Jensen and William Meckling made a similar comment with respect to finance. The theory of the firm was an “empty box” or a “black box” that provided no theory about “how the conflicting objectives of the individual participants are brought into equilibrium.” The result of Jensen and Meckling’s seminal reframing of corporate law in agency cost terms, and so into something far broader than disputes over statutory language, was that both Manning’s empty skyscrapers and Jensen and Meckling’s empty box began to be filled. The essay proceeds by tracking how corporate law became corporate governance – from legal rules standing alone to legal rules interacting with non-legal processes and institutions – through three somewhat idiosyncratically chosen but nonetheless related examples of how we have come to usefully complicate the inquiry into the structures that bear on corporate decision-making and performance. Part I frames the first level of complication in moving from law to governance by defining governance broadly as the company’s operating system, a braided framework encompassing legal and non-legal elements. Part II then adds a second level of complication by treating corporate governance dynamically: corporate governance becomes a path dependent outcome of the tools available when a national governance system begins taking shape, and the process by which elements are added to the governance system going forward – driven by what Paul Milgrom and John Roberts call “supermodularity.” That characteristic reads importantly on both the difficulty of corporate governance, as opposed to corporate law, reform and the non-intuitive pattern of the results of reform: significant reform leads to things getting worse before they get better. Part II then further complicates corporate governance by expanding it beyond the boundaries of the corporation, treating particular governance regimes as complementary to other social structures – for example, the labor market, the capital market and the political structure – that together define different varieties of capitalism. Next, Part III considers commonplace, but I will suggest misguided, efforts to take a different tack from Parts I and II: to simplify rather than complicate corporate governance analysis by recourse to now familiar single factor analytic models: stakeholder theory, team production, director primacy, and shareholder primacy. Part III suggests that these reductions are neither models nor particularly helpful; they neither bridge the contextual specificity of most corporate governance analysis nor address the necessary interaction in allocating responsibilities among shareholders, teams and directors. As well, these “models” are static rather than dynamic, a serious failing in an era in which the second derivative of change is positive in many business environments and Schumpeter seems to be getting the better of Burke. Part IV concludes by examining the importance of a corporate governance system’s capacity to respond to changes in the business environment: the greater the rate of change, the more important is a governance system’s capacity to adapt and the less important its ability to support long-term firm-specific investment