Abstracts and Keywords for OSO —

Business Persons: A Legal Theory of the Firm

by Eric W. Orts

Book abstract:

Business Persons: A Legal Theory of the Firm, Eric W. Orts
This book explains the legal structure of business firms as they operate in the world today. It describes the legal foundations or “matrix” from which all firms are built, managed, and governed. The legal theory of the firm presented here provides a counterweight to the currently dominant economic approaches to understanding firms. The book describes how business enterprises work, the laws governing them, and how they change over time in terms of their institutional purposes and values.
Basic legal ideas emphasized in the book include the “real fictions” of firms, the role of constructed “entities,” and the recognition of firms as “persons.” Other foundations of the firm include agency law, organizational contracts, and private property—and an appreciation of how these legal elements fit together to compose the “business persons” of modern firms. An institutional legal theory of the firm is developed that embraces both the “bottom-up” perspective of business participants and the “top-down” rule-setting perspective of government.
The book discusses the important feature of limited liability of both firms themselves and participants in them, as well as the shifting legal boundaries of firms in different circumstances. A typology of different kinds of firms is presented ranging from entrepreneurial one-person start-ups to complex corporate groups. New forms of hybrid social enterprises are also reviewed. Practical applications include recommendations about two contemporary problems: executive compensation and rights of political speech of business “persons” such as highlighted in the landmark Citizens United case.
Keywords for book.
Theories of the firm, business enterprises, legal persons, legal entities, legal fictions, boundaries of firms, limited liability, corporations, hybrid social enterprises, executive compensation, Citizens United.

Chapter abstracts:

Introduction / Introduction: The Recognition and Boundaries of the Firm
The introduction discusses the role of law in the social recognition, conceptual definition, and historical evolution of business enterprises, also known as firms. It describes firms as social institutions created by legal technologies in a global historical context. Law distinguishes firms from other institutions (such as charities and nation-states). Law also enables business participants to construct internal authority structures. Governments use law to set the external “rules of the game” for firms in terms of their management, financing, and legal liability.
After outlining the chapters of the book, the introduction describes the overall project as both “conservative” in the sense of recovering forgotten foundational knowledge about business firms and “progressive” in the sense of emphasizing the considerable flexibility available for business participants as well as governments with respect to the objectives, purposes, and values of firms.
Keywords for Introduction
Recognition of firms, boundaries of firms, legal technologies, legal theory of the firm, purposes and values of firms, flexibility of firm structures.
Chapter 1 / 1. Foundations of the Firm I: Business Entities and Legal Persons
This chapter sets forth a conceptual understanding of the firm as an organizational “entity” with “legal personality.” This idea is foundational for a modern legal theory of the firm. The chapter resurrects ideas regarding the nature of the business corporation (as one specific kind of firm). It also explains how thinking of firms as legal fictions, entities, and persons is key to understanding how they have evolved over time. Against contemporary economists and legal scholars who have been impatient and dismissive of these ideas, the chapter argues that fictions, entities, and persons are essential concepts that are useful for many different purposes in business practice. These purposes include the naming, representation, and standing of firms, as well as the phenomenon of organizational “shapeshifting.” The chapter compares and contrasts “bottom-up” and “top-down” theories of the firm and argues in favor of an institutional legal theory of the firm includes both perspectives.
Keywords for Chapter 1
Business entities, legal persons, legal fictions, concession theory, participant theory, institutional theory, standing, naming, shapeshifting, representation.
Chapter 2 / 2. Legal Foundations of the Firm II: Agency, Contracts, and Property
This chapter considers laws pertaining to agency relationships, organizational contracts, and private property, which count as an additional set of legal foundations for the construction, growth, and management of firms. Various economic theories of the firm that have emphasized one or another of these elements are discussed in passing. The chapter shows that legal theory can explain how these disparate elements fit together to compose the panoply of real-world business firms today. The chapter also discusses modern revolutions in both corporate law and finance that have led to a radical fragmentation of the ownership and control of firms, leading to important roles in firm governance played by managing boards and financial investors. The chapter emphasizes the influence of debt financing, retained earnings, and complex organizational structures (such as holding companies and corporate pyramids) in many modern firms.
Keywords for Chapter 2
Agency law, organizational contracts, private property, fragmentation of ownership and control, debt financing, retained earnings, corporate boards, holding companies, corporate pyramids, complex firms.
Chapter 3 / 3. The Public/Private Distinction: Two Faces of the Business Enterprise
This chapter describes the public/private distinction and its importance in business firms. The distinction tracks different types of property in modern societies. Societies characterized primarily as engaged in “market capitalism” in which privately organized and owned enterprises predominate are distinguished from “state capitalist” societies in which government-owned and -operated firms are most prevalent. The public/private distinction explains how different approaches to firms are put into practice and how they change over time. The distinction is defended against arguments emphasizing legal indeterminacy and a structural critique. A main point is that the division of different kinds of business firms—private, public, and public-private hybrids—is accomplished through legal methods of recognition and differentiation. Market competition plays a major role in selecting the most efficient of these business forms in particular situations, but this economic competition depends on underlying legal and political foundations. The Dartmouth College case provides an historical illustration.
Keywords for Chapter 3
Public/private distinction, market capitalism, state capitalism, public-private hybrids, legal indeterminacy, structural critique, corporations, Dartmouth College.
Chapter 4 / 4. Enterprise Liability, Business Participant Liability, and Limited Liability
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This chapter examines the liability and responsibility of firms and their participants for wrongful harms to others (or “externalities”). Two kinds of liability include: (1) enterprise liability of firms themselves and (2) business participant liability (i.e., of shareholders or other equity owners, creditors, employees, and executives). The chapter describes the liability rules regarding firms and how these legal rules draw the boundaries of the firm in practice. Particular problems include enterprise liability in corporate parent-subsidiary structures and other complex groups, as well as issues of vicarious liability, outsourcing, indemnification, and “entity piercing.” A larger theme involves the social balance of liability and limited liability of “business persons” (both enterprise entities and individuals). The ability to arbitrage attributes of liability in the construction of firms (and other legal entities) has large practical implications, especially in a world in which financially sophisticated and wealthy players can game jurisdictional boundaries.
Keywords for Chapter 4
Enterprise liability, business participant liability, limited liability, externalities, parent-subsidiary liability, creditor liability, vicarious liability, outsourcing, indemnification, entity piercing.
Chapter 5 / 5. The Nomenclature of Enterprise: A Taxonomy of Modern Firms
This chapter first provides a background understanding of firms as participating in “production metamarkets” that serve widespread and usually global “consumption markets.” It then presents a menu of legal forms of private firms, including corporations, partnerships, and limited liability companies, as well as state-owned enterprises. The choice of legal forms creates many variations on the traditional “black box” of the firm along the primary dimensions of agency authority and property ownership. The names used for different enterprises are described, ranging from sole proprietorships to complex relational firms. Basic principles of organizational law distinguish business firms from other kinds of social entities, including political governments and nonprofit organizations. The chapter outlines the importance of these distinctions and provides an overview of the main choices of legal forms available to business participants, entrepreneurs, and other enterprise-organizers. New hybrid social enterprises, such as beneficial or “B” corporations, are covered as well.
Keywords for Chapter 5
Production metamarkets, corporations, partnerships, limited liability companies, state-owned enterprises, sole proprietorships, complex relational firms, entrepreneurs, hybrid social enterprises, beneficial corporations.
Chapter 6 / 6. Managing and Regulating the Shifting Boundaries of the Firm
This chapter examines the legal boundaries of the firm, which shift depending on questions that are asked (an organizational version of the “uncertainty principle”). The legal boundaries of firms refer to the management and regulation of firms both internally and externally. From an internal perspective, the setting and exercise of legal rules allow for the self-governance of most business firms. From an external perspective, different legal rules or “choice architectures” may prohibit or encourage particular behaviors of firms and their participants. These internal and external perspectives correspond to the “bottom-up” and “top-down” perspectives described in previous chapters. Considerable variation is possible with respect to the management and regulation of the boundaries of the firm. Managers and policy maker may choose to advance different objectives and values when addressing issues concerning the boundaries of the firm.
Keywords for Chapter 6
Boundaries of the firm, uncertainty principle, internal and external perspectives, bottom-up and top-down perspectives, choice architectures, purposes and values of firms.
Chapter 7 / 7. Two Applications
This chapter provides two practical applications of the legal theory of the firm elucidated in the book. One controversial issue addressed is executive compensation in corporations, which many observers believe has become disproportionate in some countries and within some firms. The chapter shows how some influential economic theories adopted simplistic “principal-agent” prescriptions which contributed to imbalance and injustice in contemporary compensation practices (e.g., through the use of stock options). An institutional legal theory offers a corrective in perspective.
A second controversial issue involves the political free-speech rights of corporations and other “business persons,” such as addressed in the controversial Citizens United case. The chapter argues that an institutional legal theory of the firm can deepen analysis and understanding on both sides of the debate. It also suggests possible directions for future compromise, such as mandatory disclosure requirements of the funding of political campaigns and other political activities of business firms.
Keywords for Chapter 7
Executive compensation, principal-agent theory, stock options, political rights of corporations, corporate persons, Citizens United, campaign financing, mandatory disclosure requirements.
Conclusion / Conclusion
The conclusion restates the argument that the legal theory of the firm advanced in the book provides an antidote to dominant economic theories of the firm. At least, a legal theory of the firm provides a needed supplement to economic theories. A legal theory of the firm also provides an interpretive framework that is open to other interdisciplinary approaches, including history, political theory, philosophy, and sociology. Pulling together themes from previous chapters, the conclusion argues that legal theory can provide a concrete and flexible account of business firms that allows for a diversity of purposes and values. This legal flexibility—from both the perspective of business participants and the perspective of government—is significantly greater than many people appreciate. A better understanding of the “legal matrix” underlying firms can empower people to change the forms of business enterprise in many different directions in the future.
Keywords for Conclusion
Legal theory of the firm, economic theories of the firm, interpretative method, interdisciplinary openness, legal matrix, institutional change, law reform.