The Board of Directors as Nexus of Contracts: A Critique of Gulati, Klein & Zolt's 'Connected Contracts' Model

Abstract:     
In corporate law scholarship, two basic models have long competed: managerialism and shareholder primacy. Managerialist theories treat the corporation as a bureaucratic hierarchy dominated by professional managers. Shareholder primacy theory formerly argued that shareholders own the corporation and, accordingly, directors and officers are mere stewards of the shareholders' interests. A more recent variant, which arguably is the dominant model in today's scholarship, rejects the idea of ownership as irrelevant to the firm as a nexus of contracts. Yet, shareholders retain a privileged position among the corporation's constituencies, because their contract with the firm has ownership-like features, including the right to vote and the fiduciary obligations of directors and officers.

The chief criteria for any model of the corporation must be the model's ability to predict the separation of ownership and control, the institutional governance structures following from their separation, and the legal rules responsive to their separation. Shareholders, who are said to own the firm, have virtually no power to control either its day-to-day operation or its long-term policies. Instead, the firm is controlled by its board of directors and subordinate managers, whose equity stake is often small. On close examination, neither managerialism nor shareholder primacy adequately explains the corporate governance features that follow from the separation of ownership and control.

This article develops an alternative model-director primacy. In this model, the corporation is a vehicle by which the board of directors hires various factors of production. Hence, the board of directors is not a mere agent of the shareholders, but rather is a sui generis body - a sort of Platonic guardian - serving as the nexus for the various contracts making up the corporation. The board's powers flow from that set of contracts in its totality and not just from shareholders. In developing this analysis, the Article uses as its principal foil the so-called "connected contracts" model recently put forward by UCLA law professors Gulati, Klein, and Zolt.

Number of Pages in PDF File: 37

Keywords: Boards of Directors, Shareholders, Nexus of Contracts

JEL Classification: G30, K22

working papers series