Corporate Law and Residual Claimants (Partial Draft)
Bernard S. Black
Northwestern University - Pritzker School of Law; Northwestern University - Kellogg School of Management; European Corporate Governance Institute (ECGI)
May 1, 2001
Stanford Law and Economics Olin Working Paper No. 217
This is a partial draft of a long-delayed project. I posted it because of continued interest in the draft, and still hope to complete it.
The conventional contractarian explanation for why only common shareholders have voting rights is that they are the firm's principal residual claimants, and therefore have an incentive to maximize firm value. This explanation doesn't fit the facts. Other claimants, including employees, creditors, preferred shareholders, option holders, suppliers, customers, and the government (as tax collector), also generally gain when a firm does well and suffer when the firm does badly.
I argue that instead of asking why only common shareholder vote, we should be asking why, in a world where common shareholders, employees, creditors, preferred shareholders, and others are all important residual claimants, are control rights (of which voting rights are only one flavor) divided as they are? To answer this question, we must explain both why common shareholders receive control rights and why other residual claimants often do not. Why don't employees, suppliers, customers, and the government receive formal control rights, unless they also own common shares? Why do preferred shareholders receive voting rights that are almost uselessly weak? Why do banks receive covenant-based contractual control rights, while trade creditors receive only nonpayment-based rights, even though trade creditors have lower-priority, hence less-fixed claims.
This article seeks more to raise questions than to answer them, but I sketch some tentative answers. In my view, multiple factors affect which claimant classes have control rights, including: the transferability of a class's residual interests; the homogeneity of interests within a claimant class; bargaining costs if different claimants receive overlapping control rights; a claimant class's access to (and incentives to obtain) the information needed to use control rights effectively; whether two claimant classes have similar incentives, so that one can monitor on behalf of the other; and whether informal control rights can substitute for formal rights.
Number of Pages in PDF File: 45
Date posted: December 27, 2009