Citations (2)



Legal Entities as Transferable Bundles of Contracts

Kenneth Ayotte

University of California, Berkeley - School of Law

Henry Hansmann

Yale Law School; European Corporate Governance Institute (ECGI)

March 3, 2012

Michigan Law Review, Forthcoming

The large modern business corporation is frequently organized as a complex cluster of hundreds of corporate subsidiaries under the common control of a single corporate parent. Our paper provides new theory and supportive evidence that help explain this structure. We focus, in particular, on the advantages of subsidiary entities in providing the option to transfer some or all of the firm's contractual rights and obligations in the future. The theory not only sheds light on corporate subsidiaries, but illuminates a basic function of all types of legal entities, from partnerships to nonprofit corporations.

We show that when, as is common, some of a firm’s key assets are contractual, both the firm’s owner(s) and the firm’s contractual counterparties are exposed to the risk of opportunism regarding assignment of the contracts. The owner faces opportunistic holdup by counterparties if counterparty consent is required to assign contracts in a sale of the entire firm. The firm’s counterparties, in turn, are exposed to opportunistic assignment if the owner can freely assign contracts without consent. This bilateral opportunism problem can be mitigated through bundled assignability: the owner is permitted to assign her contracts freely, but only as a bundle. The components of the bundle of contracts (which constitutes much of the firm itself) provide assurance of performance to counterparties. And free transferability, in turn, gives the owner liquidity without risk of holdup. Most importantly -- and least appreciated in the literature and the case law -- bundled assignability increases the owner’s incentive to make valuable investments in the firm.

We explain why legal entities provide the simplest reliable means of creating bundled assignability. Further, we support our analysis with the first empirical study of assignment clauses in commercial contracts. Firms, we show, commonly provide for bundled assignability in their contracts, and they use legal entities to define the boundaries of transferable bundles. This suggests that, in practice, contracting parties are aware of the forces underlying our theory.

Number of Pages in PDF File: 39

Keywords: legal entities, subsidiaries, assignment, theory of the firm

JEL Classification: K12, K22

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Date posted: March 5, 2012 ; Last revised: May 7, 2012

Suggested Citation

Ayotte, Kenneth and Hansmann, Henry, Legal Entities as Transferable Bundles of Contracts (March 3, 2012). Michigan Law Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2015498 or http://dx.doi.org/10.2139/ssrn.2015498

Contact Information

Kenneth Ayotte (Contact Author)
University of California, Berkeley - School of Law ( email )
215 Boalt Hall
Berkeley, CA 94720-7200
United States

Henry Hansmann
Yale Law School ( email )
P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-4966 (Phone)

European Corporate Governance Institute (ECGI)
B-1050 Brussels
HOME PAGE: http://www.ecgi.org
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