Of Directorships: Reconfiguring the Theory of the Firm

66 Pages Posted: 28 Aug 2023

See all articles by Tomer Stein

Tomer Stein

University of Tennessee College of Law

Date Written: August 27, 2023

Abstract

This Article develops a novel account of directorships and then uses it to reconfigure the theory of the firm. This widely accepted theory holds that firms emerge to satisfy the economic need for carrying out vertically integrated business activities under a fiduciary contract that substitutes for the owners’ multiple agreements with contractors and suppliers. As per this theory, the fiduciary contract is inherently incomplete, yet often preferable: while it cannot address all future contingencies in the firm, it will effectively direct all unaccounted-for firm events by placing them under the owners’ purview as a matter of default, or residual right. Under this contractual mechanism, firm owners, such as corporate shareholders, acquire the status of residual claimants who have the power to decide on all contractually unenumerated contingencies.

This view of the firm is conceptually flawed and normatively mistaken. Firms do carry vertically integrated business activities managed by their fiduciaries, but those fiduciaries—agents, trustees, and directors—are not functional equivalents from either the legal or economic standpoint. Unlike agents and trustees who receive commands from principals and settlors, respectively, directors manage the firm’s business by exercising decisional autonomy. Conceptually, shareholders who hire directors do not run the firm’s business as residual claimants. Rather, it is the directors who manage the firm as residual obligors—all contractually unaccounted for contingencies are placed under the fiduciary’s purview as a matter of obligation. This feature makes directorship an attractive management mechanism that often outperforms other fiduciary mechanisms, and the residual-claimant structure that stands behind them, in a broad variety of contexts. By developing this critical insight, the Article proposes not only to reconfigure the prevalent theory of the firm, but also to redesign both federal and state laws in a way that will facilitate directorships not only in corporations, but also across several indispensable dimensions of our financial, communal, and familial organizations.

Keywords: corporate law, theory of the firm, directors

Suggested Citation

Stein, Tomer, Of Directorships: Reconfiguring the Theory of the Firm (August 27, 2023). University of Tennessee Legal Studies Research Paper, Available at SSRN: https://ssrn.com/abstract=4553445 or http://dx.doi.org/10.2139/ssrn.4553445

Tomer Stein (Contact Author)

University of Tennessee College of Law ( email )

1505 West Cumberland Avenue
Knoxville, TN 37996
United States

HOME PAGE: http://https://law.utk.edu/directory/tomer-s-stein/

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