Specific Investment: Explaining Anomalies in Corporate Law

Abstract:     
This essay has two goals: to praise Professor Robert Clark as a remarkable corporate scholar, and to explore how his work has helped to advance our understanding of corporations and corporate law. Clark wrote his classic treatise at a time when corporate scholarship was dominated by a principal-agent paradigm that viewed shareholders as the principals or sole residual claimants in public corporations and treated directors as shareholders' agents. This view naturally led contemporary scholars to assume the chief economic problem of interest in corporate law was the "agency cost" problem of getting corporate directors to do what shareholders wanted them to do (presumably, to maximize share value). Clark's treatise in some ways adopted this perspective. It also, however, carefully noted important but anomalous aspects of corporate law that the principal-agent model could not explain, including directors' extensive and sui generis legal powers; the fact that directors control dividends; the device of legal personality; and the open-ended rules of corporate purpose. Today, economic and legal scholars have begun to move beyond agency costs and to focus attention on a second economic problem that arises in public corporations: protecting specific investment. When corporate production requires more than one individual or group to make specific investments, problems of intrafirm opportunism arise as shareholders try to exploit each other and try as well to exploit creditors, employees, customers, and other groups that make specific investments. Board authority, while worsening agency costs, may provide a second-best solution to such intrafirm rent-seeking. This perspective can explain the important corporate law anomalies Clark described. Because Clark wrote his treatise at a time when the principal-agent paradigm was ascendant, he could not himself easily explain the anomalies he carefully noted. His treatise nevertheless showed both remarkable insight and remarkable honesty in discussing them. As result Clark played an important role in drawing scholars' attention to the limitations of the principal-agent model and in spurring them to explore alternatives. His treatise remains one of the best available starting points for the reader who wants an accurate portrait of the structure of corporate law.

Keywords: corporate law, principal-agent, agency costs, boards of directors, legal personality, specific investment, law and economics, scientific revolutions, nexus of contracts, shareholder wealth maximization, residual claimants, theory of the firm, capital lock-in, shareholder primacy, team production

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