The Merging of Ownership and Control

Abstract

What if shareholders controlled every decision their company makes? This seemingly simple idea threatens to upend the modern corporation.

Shareholders own the corporation and directors and officers manage the corporation—a “separation of ownership and control” that has become a defining characteristic of our modern economy. As per conventional wisdom, the law enables separation of ownership and control by not prohibiting owners and employees from exercising their contractual freedom to hire and work for one another.

This Article demonstrates that this widely held view is incomplete and detrimental to the economy. Much of the economic activity that utilizes the corporate form has relied on a legal mandate, rather than permission, to establish the separation between ownership and control.

While ordinary employer-employee contracts, such as an agreement between a store owner and store clerk, rely on the parties’ ability to contract for and alter fiduciary arrangements on an ongoing basis, many shareholders pool their money together to hire directors for the exact opposite reason. They rely on the mandatory separation of ownership and control in order to effectively combine their assets under the direction of a fiduciary who answers only to the firm, and not any individual investor. Absent the ability to rely on a legally mandated independent director, such shareholders would not be able to coordinate and combine their assets. The shareholders’ various competing interests and rights would be too conflicting and complex to organize contractually.

Yet, an amendment signed into law in July 2024 is set to unravel this economically essential legal mechanism—it promises to merge ownership and control. This legislation was able to pass at least partly because extant scholarship lacks a theory to explain why a mandatory separation of ownership and control is an indispensable mechanism. This Article fills this gap and calls for the repeal of this watershed amendment.

Keywords: corporate law, corporate governance, directors, shareholder agreements, theory of the firm