Law and the Rise of the Firm

70 Pages Posted: 31 Jul 2006

See all articles by Henry Hansmann

Henry Hansmann

Yale University - Law School; European Corporate Governance Institute (ECGI)

Reinier Kraakman

Harvard Law School; European Corporate Governance Institute

Richard Squire

Fordham University School of Law

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Abstract

Organizational law empowers firms to hold assets and enter contracts as entities that are legally distinct from their owners and managers. Legal scholars and economists have commented extensively on one form of this partitioning between firms and owners: namely, the rule of limited liability that insulates firm owners from business debts. But a less-noticed form of legal partitioning, which we call entity shielding, is both economically and historically more significant than limited liability. While limited liability shields owners' personal assets from a firm's creditors, entity shielding protects firm assets from the owners' personal creditors (and from creditors of other business ventures), thus reserving those assets for the firm's creditors. Entity shielding creates important economic benefits, including a lower cost of credit for firm owners, reduced bankruptcy administration costs, enhanced stability, and the possibility of a market in shares. But entity shielding also imposes costs by requiring specialized legal and business institutions and inviting opportunism vis-à-vis both personal and business creditors. The changing balance of these benefits and costs helps explain the evolution of legal entities across time and societies. To both illustrate and test this proposition, we describe the development of entity shielding in four historical epochs: ancient Rome, the Italian Middle Ages, England of the 17th-19th centuries, and the United States from the 19th century to the present.

JEL Classification: D23, G32, G33, K22, L22, N23

Suggested Citation

Hansmann, Henry and Kraakman, Reinier H. and Squire, Richard C., Law and the Rise of the Firm. Harvard Law Review, Vol. 119, No. 5, pp. 1333-1403, March 2006; Harvard Law and Economics Discussion Paper No. 546. Available at SSRN: https://ssrn.com/abstract=921429

Henry Hansmann (Contact Author)

Yale University - Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-4966 (Phone)

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Reinier H. Kraakman

Harvard Law School ( email )

1575 Massachusetts
Hauser 406
Cambridge, MA 02138
United States
617-496-3586 (Phone)
617-496-6118 (Fax)

European Corporate Governance Institute ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Richard C. Squire

Fordham University School of Law ( email )

150 West 62nd Street
New York, NY 10023
United States
212-964-1584 (Phone)

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