A previous blogpost already announced the publication of the third edition of “The Anatomy of Corporate Law”. The first chapter of the book can be read here. This blogpost reviews The Anatomy in more detail. A Dutch version of this review was published in “Tijdschrift voor Privaatrecht” (TPR).
The Anatomy of Corporate Law is, without a doubt, one of the most important works in the comparative and economic analysis of corporate law.
The Anatomy studies almost all of the important topics in corporate law, ranging from the basic governance structure to takeovers and securities regulation. It should be mandatory reading for corporate law scholars all over the world and can serve as an excellent basis for teaching comparative corporate law to students.
The third edition of 2017 (long awaited after previous editions in 2004 and 2009) brings no revolutionary changes. Most notably, two new authors contributed to the third edition, Mariana Pargendler (FGV Law School, São Paulo) and Wolf-Georg Ringe (University of Hamburg), who joined forces with the authors of the previous editions (Reinier Kraakman, John Armour, Paul Davies, Luca Enriques, Henry Hansmann, Gerard Hertig, Klaus Hopt, Hideki Kanda and Edward Rock). In addition, the editors of the first edition took a step back into a more advisory role, while John Armour and Luca Enriques took over the role of “General Editors”. Finally, two associate authors, Sofie Cools (KU Leuven; Max Planck Institute of Comparative and International Private Law) and Gen Goto (University of Tokyo) also contributed to the third edition. In this way, the third edition of The Anatomy of Corporate Law introduces new generations of corporate law scholars. With the help of Brazilian scholar Mariana Pargendler, the third edition also adds Brazil, an emerging market economy, to the “core jurisdictions” that are analyzed, the others being the United States, the United Kingdom, France, Germany, Italy and Japan.
The Anatomy of Corporate Law and its general approach
The general approach of the third edition is very similar to the previous editions. The aim of The Anatomy remains to be “international, functional, neutral and brief”. In The Anatomy’s “functional approach”, the function of corporate law is largely equated with its economic function. The authors keep the assumption of previous editions that corporate law should maximize social welfare. While the authors do not take an explicit stance on whether this is best achieved through maximizing welfare of the shareholders of the company, it does seem to be an underlying assumption of The Anatomy that this is ordinarily the case.
Due to its brief nature, The Anatomy obviously also has its limitations in scope. First, it focuses mainly on public corporations, leaving aside closed corporations and non-corporate forms such as the Limited Liability Company (LLC) and partnerships. Second, The Anatomy is obviously limited to corporate law. It briefly covers some aspects of bankruptcy law in chapter 5 on “transactions with creditors” and of securities regulation in chapter 9 on “corporate law and securities markets”, but this remains limited in scope.
The conceptual framework of The Anatomy
The conceptual framework used in the third edition remains largely the same as in previous editions. The authors still describe a corporation through five essential characteristics: (1) separate legal personality and “entity shielding” (which includes priority of business creditors and liquidation protection), (2) limited liability of shareholders (or “owner shielding”), (3) transferable shares, (4) delegated management with a board (elected by the shareholders), and (5) investor ownership (meaning that shareholders have the right to control the firm and receive its earnings). The first function of corporate law is to provide enterprises with a legal form that possesses all of these characteristics.
A second function of corporate law, which receives more importance in The Anatomy, is to address the three agency problems that are present in corporations: (1) between managers and shareholders, (2) between controlling shareholders and non-controlling shareholders, and (3) between shareholders and other third parties (such as creditors and employees). These relationships are characterized by a possibility for the agent to act opportunistically in its own interest instead of the principal’s. According to The Anatomy, the goal of corporate law is to search for “optimal solutions to the corporation’s agency problems” (p. 31), i.e. reducing agency costs.
The Anatomy classifies these solutions into ten “legal strategies” for agency problems, which are summarized in the table below (p. 32).
|Agent constraints||Affiliation terms||Incentive alignment||Appoint-ment rights||Decision rights|
“Rules” stipulate ex ante specific actions that should or should not be taken by agents, while “standards” are more general and are only given precise content ex post when they are adjudicated. In the “affiliation” strategy, the law can set the “terms of entry” (for example by requiring disclosure of certain information) or can give principals an “exit” opportunity (for example giving shareholders the right to sell their shares). The “trusteeship” strategy aims to eliminate the conflict of interest of the agent (for example through independent directors), while the “reward” strategy incentives agents to act in the principal’s interests (for example through a performance-based compensation package). Appointment rights can also help solve agency problems, for example by giving shareholders the right to select or remove directors. Finally, the decision rights strategy give shareholders the right to initiate or ratify certain decisions, commonly only the most fundamental transactions.
The conceptual framework of the Anatomy, with the five chore characteristics of a corporation (chapter 1) and with the agency problems and legal strategies (chapter 2), is then applied in the subsequent chapters to the whole range of corporate law topics. Chapter 3 looks at the basic governance structure and at “ordinary business decisions” from the perspective of shareholders as a class, while chapter 4 looks at the same topic from the perspective of minority shareholders and non-shareholder constituencies. Chapter 5 studies the legal strategies that govern agency relationships in transactions with creditors, while Chapter 6 looks at related-party transactions. Chapter 7 looks at what special corporate law rules apply to “fundamental changes”, such as charter amendments, mergers or share issuances. Chapter 8 describes the legal strategies in “control transactions” such as takeovers, and chapter 9 looks at securities regulation and enforcement. Chapter 10 concludes and extends the analysis of the Anatomy beyond its scope.
Important changes in the content of the third edition
In the paragraphs below, I briefly note some of the more important changes to the chapters of the Anatomy. First, Chapter 3 devotes more attention to shareholder activism and the increased institutionalization of ownership structures.
In chapter 4, the “one share, one vote” debate and dual class shares are discussed more elaborately, which makes sense given the recent revival in the academic debate after Snap’s decision to go public with a class of non-voting shares.
An even more fundamental change in chapter 4 is the attention for “external constituencies”, which shows the hand of new author Mariana Pargendler. This part studies mechanisms that protect constituencies other than shareholders, managers, creditors or employees, such as for example members of the general public or members of a specific minority group. This include juicy topics like non-financial disclosures, gender quotas, golden shares, state owned enterprises, and directors’ duties towards other constituencies. While the authors do not take a strong view here, they do seem to be rather skeptical towards these mechanisms.
Chapter 8 shows some new elements in the explanation for the differences in takeover regulation between the core jurisdictions. In particular, more emphasis is given to political economy explanations. The authors note a “backlash against a perceived sale of strategic firms into foreign hands” (p. 239) and protectionist reactions of governments to foreign takeovers, including for example laws in France that require government approval for takeovers of companies in key sectors. The authors also mention the example of the EU Takeover Directive, which they see as an example where “political considerations, lobbying efforts, and regulatory capture” (p. 241) were very important. This illustrates well that a “functional” or “economic” explanation (based on divergences in ownership structures) is still favoured by the authors of the Anatomy, but that the third edition also more and more integrates other potential explanations of a political nature.
Similarly to chapter 8, chapter 9 on “corporate law and securities markets” also relies on a mix of ownership structure and political economy arguments to explain differences in disclosure regimes. For example, the authors note that controlling shareholders have an incentive to lobby against stronger securities regulation, while managers may be less averse to broad disclosures. In addition, securities laws seem to be strengthened especially afterwards financial crises or corporate scandals.
The concluding chapter (chapter 10) has almost entirely been rewritten. Most interestingly, the authors identify some trends and some questions that are currently debated in corporate law scholarship. First, they notice an increased protection of shareholders, mainly through more disclosures (affiliation strategy), say-on-pay votes for shareholders (decision rights strategy) and a more important role for independent directors (trusteeship strategy). On the other hand, countries seem to be more and more willing to allow deviations from the idea of proportional voting, as is evidenced by the IPO of Snap mentioned above.
Second, the authors also identify an increasing importance of blockholders – large institutional investors without a controlling interest – in the ownership structure of corporations. This adds a second layer of agency costs, between asset managers and their beneficiaries. It also raises the question of hedge fund activism: is this a good thing, because it mitigates the rational apathy of small shareholders and the agency costs of asset managers, or does it lead to excessive short-termism by companies? In addition, the authors note that state ownership of corporations is still an important feature of the ownership structure in many countries, even though it was once pronounced almost extinct.
The Anatomy concludes with the authors saying: “none of us has a crystal ball to predict the future” (p. 272). In the end, the authors do believe, however, that the Anatomy’s conceptual framework “will continue to be relevant as new questions emerge and old ones resurface” (p.272). Considering its importance for corporate law scholarship, thirteen year after the first edition, I am inclined to agree with this statement.
KRAAKMAN, J. ARMOUR, P. DAVIES, L. ENRIQUES, H. HANSMANN, G. HERTIG, K. HOPT, H. KANDA, M. PARGENDLER, W.-G. RINGE en E. ROCK, The Anatomy of Corporate Law. A Comparative and Functional Approach, Oxford, Oxford University Press, 2017, 281 p.