[*] Professor of Law, University of Kentucky College of Law. A.B., 1966, Centre College; J.D., 1969, University of Kentucky; LL.M., 1971, Harvard University. The author expresses his appreciation for reviews of drafts of this Article by James D. Cox, Thomas Lee Hazen, and Morey W. McDaniel. Also, special thanks go to my colleagues at the University of Kentucky John H. Garvey, Alvin L. Goldman, Thomas P. Lewis, Martin J. McMahon, and John M. Rogers, each of whom provided thoughtful comments during the writing of this Article. Finally, I thank my research assistant Dustan Chad McCoy for the tireless efforts and questioning attitude that he brought to the project. Return to text.

[1] Adolph A. Berle, Jr., For Whom Corporate Managers Are Trustees: A Note, 45 HARV. L. REV. 1365, 1367 (1932). Return to text.

[2] The law and economics movement analyzes nearly all aspects of law. See, e.g., RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW (4th ed. 1992); A. MITCHELL POLINSKY, AN INTRODUCTION TO LAW AND ECONOMICS (2d ed. 1989).

The foundation works for the Contractarian position include, or are explained in, Armen A. Alchian & Harold Demsetz, Production, Information Costs, and Economic Organization, 62 AM. ECON. REV. 777 (1972); Steven N. S. Cheung, The Contractual Nature of the Firm, 26 J.L. & ECON. 1 (1983); Ronald H. Coase, The Nature of the Firm, 4 ECONOMICA 386 (1937); Eugene F. Fama & Michael C. Jensen, The Separation of Ownership and Control, 26 J.L. & ECON. 301 (1983); Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. FIN. ECON. 305 (1976). Return to text.

[3] See RICHARD A. POSNER & KENNETH E. SCOTT, ECONOMICS OF CORPORATION LAW AND SECURITIES REGULATION (1980); ROBERTA ROMANO, FOUNDATIONS OF CORPORATE LAW (1993); FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW (1991) [hereinafter EASTERBROOK & FISCHEL, ECONOMIC STRUCTURE]; Henry N. Butler, The Contractual Theory of the Corporation, 11 GEO. MASON U. L. REV. 99 (1989); Frank H. Easterbrook & Daniel R. Fischel, The Corporate Contract, 89 COLUM. L. REV. 1416 (1989) [hereinafter Easterbrook & Fischel, The Corporate Contract]. Return to text.

[4] In what is something of an overstatement but nonetheless generally correct, Kornhauser says that the revolution in corporate law sparked by the Contractarians has "transformed not only our understanding of the law, but the law itself . . . ." Lewis A. Kornhauser, The Nexus of Contracts Approach to Corporations: A Comment on Easterbrook and Fischel, 89 COLUM. L. REV. 1449 (1989). Return to text.

[5] Even scholars who do not accept fully the Contractarian view may consider it premature to declare that the Contractarians lost in their bid to eliminate all mandatory fiduciary duties. See, e.g., Thomas L. Hazen, The Corporate Persona, Contract (and Market) Failure, and Moral Value, 69 N.C. L. REV. 273, 288 (1991) (referring to "the demise of the fiduciary principle in corporate governance"). Nonetheless, as more fully articulated herein, society will continue to require some significant level of fiduciary duties for corporate managers for the foreseeable future.

Interestingly, in this regard, Professor DeMott found that fiduciary duties actually may still be expanding into new areas. Deborah A. DeMott, Beyond Metaphor: An Analysis of Fiduciary Obligation, 1988 DUKE L.J. 879, 909 ("commercial franchises, distributorship relationships, a bank's relationship with its borrowers and its depositors, and the relationship between holders of executive and nonexecutive interests in oil and gas estates"). Return to text.

[6] Articles expressing the varying degrees of disagreement with the Contractarian position include Lucian A. Bebchuk, The Debate on Contractual Freedom in Corporate Law, 89 COLUM. L. REV. 1395 (1989); Victor Brudney, Corporate Governance, Agency Costs, and the Rhetoric of Contract, 85 COLUM. L. REV. 1403 (1985); Bernard S. Black, Is Corporate Law Trivial? A Political and Economic Analysis, 84 NW. U. L. REV. 542 (1990); Douglas M. Branson, Assault on Another Citadel: Attempts To Curtail the Fiduciary Standard of Loyalty Applicable to Corporate Directors, 57 FORDHAM L. REV. 375 (1988); DeMott, supra note 5, at 915-23; Melvin A. Eisenberg, The Structure of Corporation Law, 89 COLUM. L. REV. 1461 (1989); Hazen, supra note 5; John C. Coffee, Jr., The Mandatory/Enabling Balance in Corporate Law: An Essay on Judicial Role, 89 COLUM. L. REV. 1618 (1989) [hereinafter Coffee, Essay]; John C. Coffee, Jr., No Exit? Opting Out, the Contractual Theory of the Corporation, and the Special Case of Remedies, 53 BROOK. L. REV. 919 (1988) [hereinafter Coffee, No Exit]. Return to text.

[7] This is not to imply that all debates about the shape of corporate fiduciary duties were suspended during the debate regarding elimination of mandatory fiduciary duties. Indeed, many of the articles cited in the immediately preceding footnote deal in varying degrees with the appropriate shape of mandatory fiduciary duties. See, e.g., Eisenberg, supra note 6. Return to text.

[8] See infra notes 13-15 and accompanying text (defining "economic efficiency"). Return to text.

[9] See infra notes 19-29 and accompanying text (discussing the moral justifications offered for the pursuit of economic efficiency). Return to text.

[10] Some commentators express a similar view regarding the need for broadly applied principles. See, e.g., John C. Coffee, Jr., Unstable Coalitions: Corporate Governance as a Multi-Player Game, 78 GEO. L.J. 1495, 1547-48 (stating that "a narrow preoccupation with fiduciary duties has long been the hobgoblin of law professors"). Coffee recognizes the need for a "fuller normative theory." Id. Return to text.

[11] This Article is limited in the discussion of corporate fiduciary duties to the standards applicable to "managers," which include the traditional groups of officers and directors but exclude owners. Owners may make corporate "management" decisions, when, for example, they vote to approve a merger, and, under traditional corporate law, certain actions of majority stockholders have been subjected to scrutiny under fiduciary principles. See, e.g., Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983) (involving a fiduciary duty imposed on a majority stockholder voting on affiliated merger); Swinney v. Keebler Co., 329 F. Supp. 216 (D.C. 1971), rev'd, 480 F.2d 573 (4th Cir. 1973) (involving a fiduciary duty imposed on a majority stockholder selling majority block of voting stock). Notwithstanding, out of practical necessity, the discussion in this Article is limited to fiduciary duties as applied to "managers," although much of what is proposed in this piece would seem applicable to stockholders' management decisions, especially when the decisions are undertaken by a majority or controlling stockholder. Return to text.

[12] Pareto criteria, more specifically the concept of Pareto superiority, is defined and discussed in the discussion accompanying note 56 infra. Return to text.

[13] For a discussion of other definitions of economic efficiency, see Jules L. Coleman, Efficiency, Utility, and Wealth Maximization, 8 HOFSTRA L. REV. 509, 512 (1980). Return to text.

[14] See POSNER, supra note 2, at 11-15. Return to text.

[15] Posner characterizes the permissibility of voluntary exchanges as a "basic economic principle" and discusses its integral role in achieving economic efficiency. POSNER, supra note 2, at 9-15. Return to text.

[16] For an overview of the Contractarian position on corporate fiduciary duties, see Butler, supra note 3. Return to text.

[17] In arguing that managers and investors should be left free to determine the extent, if any, of managers' fiduciary duties, Easterbrook and Fischel state, "[J]ust as there is no right amount of paint in a car, there is no right relation among managers, investors, and other corporate participants." Easterbrook & Fischel, The Corporate Contract, supra note 3, at 1428. Return to text.

[18] See, e.g., id. at 1433, 1444-45. More specifically, Contractarians argue that society should enact corporate law that "fills in the blanks and oversights with the terms that people would have bargained for had they anticipated the problems and been able to transact costlessly in advance." Id. at 1445. In another piece, Professor Fischel states that "optimal fiduciary duties should approximate the bargain that investors and managers would reach if transaction costs were zero." Daniel R. Fischel, The Corporate Governance Movement, 35 VAND. L. REV. 1259, 1264 (1982). Judge Posner suggests that implied consent may be inferred "by trying to answer the hypothetical question whether, if transaction costs were zero, the affected parties would have agreed . . . ." Richard A. Posner, The Ethical and Political Basis of the Efficiency Norm in Common Law Adjudication, 8 HOFSTRA L. REV. 487, 494 (1980). Return to text.

[19] Thus, for example, Posner defends his own concept of efficiency, which he views as wealth maximization, as a concept that, if pursued, "will produce an ethically attractive combination of happiness, of rights (to liberty and property), and of sharing with less fortunate members of society." Posner, supra note 18, at 487. See also Coleman, supra note 13, at 528-30. Both Calabresi and Dworkin have observed that wealth maximization as a goal must be considered only instrumental. Guido Calabresi, An Exchange: About Law and Economics; A Letter to Ronald Dworkin, 8 HOFSTRA L. REV. 553, 556 (1980); Ronald M. Dworkin, Is Wealth a Value?, 9 J. LEGAL STUD. 191 (1980). Return to text.

[20] The works of Jeremy Bentham and John Stuart Mill provided the foundations for utilitarianism. See JEREMY BENTHAM, PRINCIPLES OF MORALS AND LEGISLATION (1789); JOHN STUART MILL, UTILITARIANISM (1863). For modern discussions of utilitarianism, see J.J.C. SMART & B. WILLIAMS, UTILITARIANISM (1973); H.L.A. Hart, Between Utility and Rights, 79 COLUM. L. REV. 828 (1979). Return to text.

[21] See Coleman, supra note 13, at 510. Professor Stone describes the pursuit of wealth maximization as a "crude sort of utilitarianism." Christopher D. Stone, Corporate Social Responsibility: What It Might Mean, If It Were Really To Matter, 71 IOWA L. REV. 557, 570 (1986).

The pursuit of economic efficiency, certainly if defined as Pareto criteria, has been viewed as promoting the utilitarian goal of maximizing total utility. Richard A. Posner, Utilitarianism, Economics, and Legal Theory, 8 J. LEGAL STUD. 103 (1979); Posner, supra note 18, at 491-92 (describing Pareto superiority as having a "utilitarian premise"). Return to text.

[22] Obviously, this still leaves the problems of externalities or adverse effects on non-trading parties. Return to text.

[23] Coleman summarizes these criticisms as "those which do not question the consequentialist character of utilitarianism" (e.g., criticisms based on the uncertainty of "whose utilities or preferences should count and which of a person's preferences should count; " criticisms based on distributive considerations; and criticisms based on the "interpersonal-utility comparison problem"), as well as those criticisms that do question the consequentialist character of utilitarianism (e.g., the criticism "that utilitarianism is an impoverished moral theory, incapable of accounting for the full range of moral obligation and right action"). Coleman, supra note 13, at 511. Related to the latter, Judge Posner observed, "The fact that one person has a greater capacity for pleasure than another is not a very good reason for a forced transfer of wealth from the second to the first." POSNER, supra note 2, at 12. Hart recognizes that utilitarianism "ignores . . . the moral importance of the separateness of persons." Hart, supra note 20, at 831. Professor Dworkin states, harshly, that "utilitarianism, as a general theory of either value or justice, is false and its present unpopularity is well-deserved." Ronald M. Dworkin, Is Wealth a Value?, 9 J. LEGAL STUD. 191, 216 (1980). Return to text.

[24] For an excellent comparison of utilitarianism and Kantianism, the two moral theories most prevalently employed in the moral justification for capitalism and, more specifically, the pursuit of economic efficiency, see JEFFERIE G. MURPHY & JULES L. COLEMAN, PHILOSOPHY OF LAW 70-82 (1990). Return to text.

[25] For a discussion and criticism of this line of reasoning, see Coleman, supra note 13, at 531-40. Return to text.

[26] For a compact, but elegant description of Kantianism, see MURPHY & COLEMAN, supra note 24, at 75-82. Separately, Murphy has written extensively about Kant. J. MURPHY, KANT: THE PHILOSOPHY OF RIGHT (1970). Return to text.

[27] See ROBERT NOZICK, ANARCHY, STATE AND UTOPIA (1974). Return to text.

[28] See Richard A. Epstein, Causation and Corrective Justice: A Reply to Two Critics, 8 J. LEGAL STUD. 477, 487-88 (1979). Professor Epstein uses the advance of individual autonomy as a basis to support the legitimacy of the employment-at-will doctrine. Richard A. Epstein, In Defense of the Contract at Will, 51 U. CHI. L. REV. 947, 951 (1984) [hereinafter Epstein, In Defense]. Return to text.

[29] See Posner, supra note 18. Return to text.

[30] In her work, Frankel reports that corporate fiduciary duties "originated with the formation of . . . corporations . . . ." Tamar Frankel, Fiduciary Law, 71 CAL. L. REV. 795 (1983). Return to text.

[31] This view may not be shared by all Regulators. See, e.g., Hazen, supra 3 note 5, at 275 (stating that his article "examines the demise of the fiduciary principle in corporate governance"). Return to text.

[32] KY. REV. STAT. ANN. §§ 271B.2-020(d) (Baldwin 1994). The Kentucky provision, which is based roughly on the 1994 Revised Model Business Corporation Act (RMBCA), RMBCA § 2.02(b)(4) (1994), permits the articles of incorporation to limit monetary recovery against directors to "acts or omissions not in good faith or which involve intentional misconduct." Section 2.02(b)(4), however, uses the terms "intentional misconduct" as the extent of the right to limit monetary recovery against directors. Return to text.

[33] In Kentucky, for example, the right to limit liability applies only to directors (i.e., officers' liability cannot be limited by a company's articles of incorporation) and does not include permission to eliminate or limit a director's liability for conflict transactions, a breach of good faith, intentional misconduct, knowing violations of the law, or transactions where "the director derived an improper personal benefit." KY. REV. STAT. ANN. § 271B.2-020(2)(d) (Baldwin 1994). Return to text.

[34] The RMBCA grants appraisal rights in the case of amendments that "materially and adversely" affect certain of the stockholders' rights, including preferential rights, redemption rights, preemptive rights, or voting rights. RMBCA § 13.02(a)(4) (1994). Return to text.

[35] The Model Business Corporation Act, for example, limited the availability of appraisal rights to mergers, consolidations, and sales of substantially all of a corporation's assets other than in the regular course of business. MBCA § 80 (1991). Return to text.

[36] See, e.g., Barrett v. Denver Tramway Corp., 53 F. Supp. 198 (Del. D. 1943), aff'd, 146 F.2d 701 (3d Cir. 1944); Goldman v. Postal Tel., Inc., 52 F. Supp. 763 (Del. D. 1943).

The unfairness visited on preferred stockholders in single-company recapitalization cases generally attracted a lot of attention in earlier times. See, e.g., E. Merrick Dodd, Jr., Fair and Equitable Recapitalizations, 55 HARV. L. REV. 780 (1942); Norman D. Lattin, A Primer on Fundamental Corporate Changes, 1 W. RES. L. REV. 3 (1949); Arno C. Becht, Corporate Charter Amendments: Issues of Prior Stock and the Alteration of Dividend Rates, 50 COLUM. L. REV. 900 (1950) [hereinafter Becht, Charter Amendments]; Arno C. Becht, Changes in the Interests of Classes of Stockholders by Corporate Charter Amendments Reducing Capital and Altering Redemption, Liquidation and Sinking Fund Provisions, 36 CORNELL L.Q. 1 (1950) [hereinafter Becht, Classes of Stockholders].

Not surprisingly, the most perceptive of the more modern works is by Brudney, and his piece contains many of his observations about market failures and bargaining inequities among investors and managers. See Victor Brudney, Standards of Fairness and the Limits of Preferred Stock Modifications, 26 RUTGERS L. REV. 445 (1973). Return to text.

[37] DeMott, supra note 5, at 909. Return to text.

[38] Frankel, supra note 30, at 796. Return to text.

[39] See Ronald Daniels, Stakeholders and Takeovers: Can Contractarianism Be Compassionate?, 43 TORONTO L.J. 315, 327 (1993) (describing the factual assumptions underpinning the Contractarian position). Return to text.

[40] See, e.g., Easterbrook & Fischel, The Corporate Contract, supra note 3, at 1430 ("Investors . . . can participate or go elsewhere. . . . [Entrepreneurs or managers] cannot force investors to pay more than what the resulting investment instruments are worth; there are too many other places to put one's money."). The authors also note that "prices quickly and accurately reflect public information about firms." Id. at 1431. The authors also state that "[i]t turns out to be hard to find any interesting item that does not have an influence on price." Id. at 1432. Easterbrook and Fischel also argue that the market works to protect ignorant and unsophisticated investors through, in part, the influence of professional traders on the market price. Id. at 1435. The authors concede that market failures may exist in midstream adjustments of corporate governance provisions. Id. at 1442-44. Contractarians also do not necessarily reject the possibility of opportunistic conduct by management. See, e.g., Butler, supra note 3, at 119 ("[T]he market mechanisms may be inadequate to deal with last-period, or one-time, divergences when the agent rationally concludes that the benefits of the one-time use of discretion is worth whatever penalties may be forthcoming in the employment market for the agent's services.").

A thoughtful and interesting piece regarding market efficiency, which contains an outstanding survey of the literature in the area, is Donald C. Langevoort, Theories, Assumptions, and Securities Regulation: Market Efficiency Revisited, 140 U. PA. L. REV. 851 (1992). Return to text.

[41] See Easterbrook & Fischel, The Corporate Contract, supra note 3, at 1432 ("[I]t does not matter if markets are not perfectly efficient, unless some other societal institution does better at evaluating the likely effects of corporate governance devices. The prices will be more informative than the next best alternative, which is all anyone can demand of any device."). Coase expressed this idea earlier. See Ronald H. Coase, The Problem of Social Cost, 3 J.L. & ECON. 1 (1960). Return to text.

[42] Easterbrook & Fischel, The Corporate Contract, supra note 3, at 1429-30 ("The corporation's choice of governance mechanisms does not create substantial third-party effects—that is, does not injure persons who are not voluntary participants in the venture."). Return to text.

[43] For a list of the underlying assumptions of the Contractarian position, see Daniels, supra note 39, at 327. Return to text.

[44] Market failures exist when parties are impeded in their trading to the extent that resources cannot flow to those who are willing to pay the most for them. Hazen says that "market failure may occur when transactions do not result from meaningful consent of both parties." Hazen, supra note 5, at 276. Coleman defines market failure as "the failure of agents acting on purely individually maximizing strategies to secure a Pareto optimal or collectively rational outcome." Jules L. Coleman, Afterward: The Rational Choice Approach to Legal Rules, 65 CHI.-KENT L. REV. 177, 179 (1989). Without using the specific term, Brudney appears to consider market failure as the inability to "effect Pareto superiority or maximize efficiency." Brudney, supra note 6, at 1411. Return to text.

[45] See, e.g., Brudney, supra note 6, at 1420 ("[I]nvestors in large publicly held corporations have little or no ability to choose or negotiate the terms of management with original owners who go public or with corporate management."); Eisenberg, supra note 6, at 1521 ("It is no more likely that buyers in an initial public offering would know of variations in core fiduciary and structural rules than that buyers of insurance policies will know the fine print in their policies."); Hazen, supra note 5, at 300 ("Consent is no more meaningful in a firm that is about to go public than it is in a firm that is already publicly held."). Bebchuk, however, considers the potential for abuse less in instances of initial sales of securities by corporations than in midstream corrections. Bebchuk, supra note 6. Return to text.

[46] See, e.g., Lawrence E. Mitchell, The Fairness Rights of Corporate Bondholders, 65 N.Y.U. L. REV. 1165, 1183 (1990); Eisenberg, supra note 6, at 1518-19; William W. Bratton, Corporate Debt Relationships: Legal Theory in a Time of Restructuring, 89 DUKE L.J. 92, 156 (1989); Dale B. Tauke, Should Bonds Have More Fun? A Reexamination of the Debate over Corporate Bondholder Rights, COLUM. BUS. L. REV. 1, 22-26 (1989). Return to text.

[47] Contractarians admit this is their toughest case. See, e.g., Easterbrook & Fischel, The Corporate Contract, supra note 3, at 1442-44. On a theoretical level, however, I fail to see the difficulty for Contractarians. The obvious theoretical answer is that the market discounts the initial price of the investment to reflect the risk of a midstream adjustment. Assumedly, the reason Easterbrook and Fischel do not make that argument is because they believe that there is a market failure respecting this term.

But to argue ex ante consent and payment for assuming the risk of a midstream adjustment seems less of a stretch than arguing, for example, that citizens consent to a negligence-based tort recovery system by accepting ex ante compensation. Such compensation, it is argued, is a result of the relatively lower operational costs of the system, which, it is assumed, would be consented to ex ante even by those who later may be denied recovery that they would have received under a strict liability system. See Posner, supra note 18, at 492-96. Return to text.

[48] Contractarians argue the therapeutic value of the market for corporate control. See, e.g., Frank H. Easterbrook & Daniel R. Fischel, The Proper Role of a Target's Management in Responding to a Tender Offer, 94 HARV. L. REV. 1161, 1165-74 (1981); Henry G. Manne, Mergers and the Market for Corporate Control, 73 J. POL. ECON. 110, 113 (1965). Applied here, the argument would run as follows: If management constructs fiduciary duties that are unfair vis-à-vis shareholders, the market value of the stock will go down, which will make the company subject to a hostile takeover. This threat keeps managers from charging too much for their services (in this case, in the form of reduced fiduciary duties). Return to text.

[49] Brudney finds that neither the market for managers nor the market for securities does much to overcome the bargaining defects. See Brudney, supra note 6, at 1420-47. Eisenberg explores a broader array of market forces and concludes that the forces do not eliminate the need for certain mandatory fiduciary principles. See Eisenberg, supra note 6, at 1488-1514. Return to text.

[50] I concede as, I trust, does the other side of the debate, the correctness of Coffee's statement that "[m]arket failures are easier to predict than prove." Coffee, supra note 10, at 1511. Return to text.

[51] Cases involving the elimination of preferred arrearage include Barrett v. Denver Tramway Corp., 53 F. Supp. 198 (Del. D. 1943), aff'd, 146 F.2d 701 (3d Cir. 1944); Western Foundry Co. v. Wicker, 85 N.E.2d 722 (Ill. 1949); State v. Bechtel, 31 N.W.2d 853 (Iowa 1948), cert. denied, 337 U.S. 918 (1949); Dratz v. Occidental Hotel Co., 39 N.W.2d 341 (Mich. 1949); Wessel v. Guantanamo Sugar Co., 35 A.2d 215 (N.J. Ch.), aff'd, 39 A.2d 431 (N.J. 1944); Buckley v. Cuban Am. Sugar Co., 19 A.2d 820 (N.J. Ch. 1940); Bove v. Community Hotel Corp. of Newport, R.I., 249 A.2d 89 (R.I. 1969). Much has been written on this matter, although most pieces are somewhat older. See, e.g., Arno C. Becht, Alterations of Accrued Dividends: I, 49 MICH. L. REV. 363, 565 (1951); E. Merrick Dodd, Accrued Dividends in Delaware Corporations—From Vested Rights to Mirage, 57 HARV. L. REV. 894 (1944); E.R. Latty, Fairness—The Focal Point in Preferred Stock Arrearage Elimination, 29 VA. L. REV. 1 (1942). Professor Brudney's piece on this matter is outstanding. See Brudney, supra note 36. Return to text.

[52] Examples of cases in which minority stockholders complained of unfairness in a freezeout situation include Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983), and Berkowitz v. Power/Mate Corp., 342 A.2d 566 (N.J. Super. Ct. Ch. Div. 1975). One of the most egregious examples of mistreatment of minority stockholders in a freezeout is Matteson v. Ziebarth, 242 P.2d 1025 (Wash. 1952). Return to text.

[53] Swinney v. Keebler Co., 329 F. Supp. 216 (D.C. 1971), rev'd, 480 F.2d 573 (4th Cir. 1973), is an interesting case involving a sale to a corporate looter, although the suit was brought on behalf of creditors (debentureholders), rather than minority stockholders. Return to text.

[54] See infra notes 139-45 and accompanying discussion. Coffee renders an especially enlightening account of the market failures that affected bondholders in the 1980s. See Coffee, supra note 10, at 1505-15. Return to text.

[55] Some Contractarians advocate the goal of wealth maximization. See, e.g., Posner, supra note 18, at 487. In any event, the fundamental point is that individual losers seem to be of little concern to Contractarians. Return to text.

[56] MURPHY & COLEMAN, supra note 24, at 182-85. Pareto criteria are discussed more extensively in Jules L. Coleman, Efficiency, Exchange, and Auction: Philosophic Aspects of the Economic Approach to Law, 68 CAL. L. REV. 221 (1980). Return to text.

[57] MURPHY & COLEMAN, supra note 24, at 186. Return to text.

[58] McDaniel observes that economists do not care "about losses to individuals. . . . Judges do care about individual losses." Morey W. McDaniel, Bondholders and Stockholders, 13 J. CORP. L. 205, 243 (1988). Society's aversion to transactions generating individual losers leads Professor Coffee to conclude that the takeovers may not remain "politically viable" unless constituency losses are eliminated. Coffee, supra note 10, at 1548. Return to text.

[59] See, e.g., Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983). Return to text.

[60] Legislatures have enacted appraisal statutes to ensure that stockholders receive "fair value" in mergers and other corporate reorganizations. See, e.g., RMBCA §§ 13.01-.03 (1994). Return to text.

[61] Single-company recapitalizations are situations in which the rights of stockholders are altered by some corporate action, most typically by a merger with a shell company or amendments to the company's articles of incorporation. Return to text.

[62] Critical comment includes Becht, Charter Amendments, supra note 36; Becht, Classes of Stockholders, supra note 36; E. Merrick Dodd, Fair and Equitable Recapitalizations, 55 HARV. L. REV. 780 (1942); Elvin R. Latty, Exploration of Legislative Remedy for Prejudicial Changes in Senior Shares, 19 U. CHI. L. REV. 759 (1952); Comment, A Standard of Fairness for Compensating Preferred Shareholders in Corporate Recapitalizations, 33 U. CHI. L. REV. 97 (1965); Rutheford B. Campbell, Jr., Voluntary Recapitalizations, Fairness, and Rule 10b-5: Life Along the Trail of Santa Fe, 66 KY. L.J. 267 (1977). Return to text.

[63] Bailey v. Tubize Rayon Corp., 56 F. Supp. 418, 422 (Del. D. 1944) (employing the terminology "so unfair as to amount to constructive fraud" and "gross unfairness," although the analysis looks more like a fairness analysis under the old Delaware block approach); Barrett v. Denver Tramway Corp. 53 F. Supp. 198 (Del. D. 1943), aff'd, 146 F.2d 701 (3d Cir. 1944) (referring to "constructive fraud," "bad faith," and "gross unfairness"); Bove v. Community Hotel Corp. of Newport, Rhode Island, 249 A.2d 89 (R.I. 1969) (refusing to select standard since the recapitalization met even the most rigorous standard of fairness).

In other instances, however, courts have indicated that no fiduciary or equitable rules are implicated by single-company recapitalizations. See Goldman v. Postal Tel., Inc., 52 F. Supp. 763 (Del. D. 1948); Franzblau v. Capital Sec. Co., 64 F.2d 744 (N.J. 1949). Return to text.

[64] MBCA § 80 (1991). Return to text.

[65] RMBCA § 13.02(4) (1994). Return to text.

[66] See, e.g., McDaniel, supra note 58, at 243 (arguing that individual investors who suffer losses from wrongful management decisions are entitled to compensation regardless of the aggregate behavior of the market). For an interesting and thoughtful consideration of the "first case" problem, see Ronald Dworkin, Why Efficiency?, 8 HOFSTRA L. REV. 563, 584-90 (1983). Return to text.

[67] This last statement, that wealth-diminishing moves should be permitted if there is payment for taking the risk of such moves, opens up a significant line of consideration that will be dealt with later but that needs to be explained here, at least briefly.

Regulators concede the appropriateness of, or at least have not objected to, a contract between shareholders and managers defining to some extent management's fiduciary duties owed to shareholders. See, e.g., Eisenberg, supra note 6, at 1463-80; Coffee, Essay, supra note 6. For example, Regulators would be unlikely to argue that redemption provisions in preferred shareholders' contracts should be considered unenforceable as inconsistent with management's fiduciary duty to shareholders. The exercise of a redemption privilege, however, is contrary to the best interests of the preferred stockholders who are subjected to the redemption. If interest rates go down and, as a result, a preferred share of stock would be worth more (but for the redemption provision), the preferred shareholders would be better off if management announced that they never intended to call the stock. The reason Regulators would not require management to forego the exercise of the redemption right is that the preferred shareholders have contracted for and are being paid to take the risk of redemption. In other words, it is permissible for managers to act contrary to the best interests of shareholders by redeeming stock because the parties consented to the redemption. These ideas are developed more fully later. Return to text.

[68] This euphemism is used by Posner, supra note 18, at 497. Return to text.

[69] Disagreement exists on this point. See, e.g., POSNER, supra note 2, at 4 ("[S]elf-interest should not be confused with selfishness."). Return to text.

[70] Id. at 13. Return to text.

[71] Posner's answers to this are brief, stating only that he makes no attempt "to defend efficiency as the only worthwhile criterion of social choice." Id. Most interestingly, in the previous edition of his book, Posner opines that the limitations of economic efficiency as an ethical criterion are "perhaps not serious ones, as such examples [as the pituitary extract case] are very rare." RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 13 (3d ed. 1986). That statement is quite curious. So long as dollars are distributed unevenly in society and the marginal value of dollars decreases as one acquires more dollars, a large percentage of all purchases by the rich will generate less utility for the rich than would have been generated if the goods that were the subject of the purchase had been allocated to a poor person. The point is that although the extremeness of Posner's example may appear to him to be a "very rare" situation, the broader version of the problem is nearly ubiquitous. Return to text.

[72] Regulators readily concede that economic efficiency is worth pursuing. They agree that value is created by allowing parties the right to enter into contracts that they consider mutually beneficial. They do not deny that the increased total utility and autonomy resulting from such transactions are worthy goals for society. For example, Professor Eisenberg states:

It is a general principle of law that a bargain should normally be enforced according to its terms, without regard to whether it is reasonable or fair. One reason for this principle is that bargains have social utility because they create joint value through trade. Another reason is that a fully informed party is normally the best judge of his own utility or interest and, therefore, of the value to him of a bargained-for performance.
Eisenberg, supra note 6, at 1463. Return to text.

[73] This position may not be inconsistent with the view of the Contractarians, who do not necessarily reject the importance of values other than economic efficiency. In fact, some economists argue that economic analyses should be entirely value-neutral. The articulated aim of these economists is "to determine which sort of rules or policies would be efficient in the abstract." This type of analysis says "nothing about the types of policies governments should impose . . . ." Coleman, supra note 13, at 549. As examples of this positive approach, Coleman cites A. Mitchell Polinsky, Private Versus Public Enforcement of Fines, 9 J. LEGAL STUD. 105 (1980); A. Mitchell Polinsky, Probabilistic Compensation Criteria, 86 Q.J. ECON. 407 (1972); Steven Shavell, Strict Liability Versus Negligence, 9 J. LEGAL STUD. 1 (1980).

More typically and more genuinely, Contractarians defend strongly the value of promoting economic efficiency. They view the pursuit of economic efficiency as a morally justifiable endeavor and thus advocate that "governments should intervene in human affairs or rearrange sociopolitical and legal institutions to promote efficiency." Coleman, supra note 13, at 549.

In any event, the fact that Contractarians and economists value economic efficiency and desire to enhance utility and autonomy does not necessarily mean that they do not recognize the significance of other values. To quote one of the champions of the law and economics movement, Judge Posner: "[Economics] does [not] answer the ultimate question of whether an efficient allocation of resources would be socially or ethically desirable." POSNER, supra note 2, at 14. In his other writings, however, Posner does deal with the question of whether an efficient allocation of resources is ethically desirable; he concludes it is. See Posner, supra note 18; Posner, supra note 21. Return to text.

[74] Of course, the rights of debentureholders, bondholders, noteholders, and general unsecured trade creditors will vary from corporation to corporation and, even within a single corporation, may break down into various classes or "series" that have different rights and obligations. Return to text.

[75] Under "human capital investors," I include "managers" (i.e., directors and officers) as a part of "employees." Therefore, I lump together in "employees" everyone from the most menial laborer to the chief executive officer.

Some commentators draw sharp distinctions between managers and employees regarding the need for fiduciary protections. Professor Coffee, for example, believes that managers are especially vulnerable to expropriation in takeovers. John C. Coffee, Shareholders Versus Managers: The Strain in the Corporate Web, 85 MICH. L. REV. 1, 73-86 (1986) (analyzing the problem of losing deferred compensation after a takeover). Professor O'Conner, on the other hand, opines that employees are much more vulnerable to expropriation. Maureen A. O'Connor, Restructuring the Corporation's Nexus of Contracts: Recognizing a Fiduciary Duty To Protect Displaced Workers, 69 N.C. L. REV. 1189, 1212-23 (1991).

Anyone considering directors as rational maximizers should read James D. Cox & Harry L. Munsinger, Bias in the Boardroom: Psychological Foundations and Legal Implications of Corporate Cohesion, 48 L. & CONTEMP. PROBS. 83 (1985). Return to text.

[76] These theories are well explained by Katherine Van Wezel Stone in Policing Employment Contracts Within the Nexus-of-Contracts Firm, 43 U. TORONTO L.J. 353, 363-69 (1993) [hereinafter Stone, Policing]; Katherine Van Wezel Stone, Employees as Stakeholders Under State Nonshareholder Constituency Statutes, 21 STETSON. L. REV. 45, 48-53 (1991) [hereinafter Stone, Employees as Stakeholders]; and O'Connor, supra note 75, at 1205-07. Return to text.

[77] The value of the residual claimants' investment increases because their income stream increases; the value of the fixed claimants' investment increases because their fixed stream of earnings becomes less risky. Return to text.

[78] See supra notes 61-63 and accompanying text. Return to text.

[79] See discussion infra part V.B. Return to text.

[80] See supra notes 59-60 and accompanying text. Return to text.

[81] Dean Robert Clark states that "from the traditional legal viewpoint, a corporation's directors and officers have a fiduciary duty to maximize shareholder wealth, subject to numerous duties to meet specific obligations to other groups affected by the corporation." ROBERT C. CLARK, CORPORATE LAW 678 (1986). Return to text.

[82] For purposes of this Article, "consent" is assumed to exist if the risk of the event is to some degree impounded on price. I leave for another day the question of whether such a definition of "consent" is well founded in moral theory, a subject that is explored and debated in the following articles: Posner, supra note 18; Coleman, supra note 13, at 531-40; and Dworkin, supra note 66, at 574-79. Return to text.

[83] A move is Pareto superior if no one is made worse off by the move and at least one person is made better off. See MURPHY & COLEMAN, supra note 24, at 182-85. Return to text.

[84] A move is Kaldor-Hicks efficient even if there are losers so long as the winners in the move could compensate the losers in the move, whether or not such compensation in fact occurs. See MURPHY & COLEMAN, supra note 24, at 186. Return to text.

[85] Morey W. McDaniel has opined similarly. Morey W. McDaniel, Stockholders and Stakeholders, 21 STETSON L. REV. 121, 134 n.43 ("[M]anagers, acting as agents for all participants, can arrange cheaply, if not costlessly, for the necessary side payments.").

McDaniel's fine works cited in this Article generally reflect views consistent with my own and helped crystalize my thinking regarding the fiduciary principle that I propose. Return to text.

[86] Neither the proposed principles nor this Article generally (at least to any significant extent) deal with the standards of care or allocations of the burdens of proof that are appropriate when investors claim that managers' violations of the proposed principles entitle them to some ex post settlement. With regard to such matters, however, the business judgment, proportionality, and intrinsic fairness tests, at least in a mechanistic matter, will continue to work well.

Thus, if investors claim that a decision of managers to purchase assets, defend against a hostile takeover, or effect an affiliated merger violates the Principle Requiring Corporate Value Maximization or violates the Principle Prohibiting Wealth Transfers, courts could (but would not be required by the proposed principles to) continue to use the business judgment, proportionality, and intrinsic fairness tests to establish managers' standards of conduct and obligations regarding the burdens of proof. Return to text.

[87] See discussion infra parts IV.D., IV.E., V. Return to text.

[88] In economic terms, to prohibit such parties from agreeing to the desired terms would be inefficient. Regulators do not generally dispute that economic efficiency is valuable. See supra note 72 and accompanying text. Return to text.

[89] Although this problem does not involve an actual violation of the Principle Prohibiting Wealth Transfers, since the principle as stated permits the parties to consent to wealth transfers, it nonetheless provides a good example of the relationship between consent and the mandatory nature of the principles. Return to text.

[90] It is interesting to relate this example to Posner's use of consent and ex ante compensation in his discussion of the moral justification for the pursuit of wealth maximization by society. See Posner, supra note 18. Return to text.

[91] Two of the most extensive treatments of this are in Eisenberg, supra note 6, and Coffee, Essay, supra note 6. More generally, see Lucian A. Bebchuk, Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments, 102 HARV. L. REV. 1820 (1989); Brudney, supra note 6. Return to text.

[92] Eisenberg also recognizes the value of permitting parties to contract in their own perceived best interests, and he attempts to protect that right in the corporate governance area, but his formula is more rigid than that of Professor Coffee's. See Eisenberg, supra note 6. Return to text.

[93] Coffee, Essay, supra note 6, at 1665. Alternatively, Professor Coffee requires that the provision represent "the substitution of an adequate alternative procedure that the parties reasonably could believe would better serve their interests." Id. Return to text.

[94] Id. Return to text.

[95] In an economic sense, of course, an efficient allocation of fiduciary duties may occur if owners and managers agree on a grossly negligent (or lower) standard of fiduciary care. On the other hand, such an arrangement can have third-party effects, since others in society may be willing to pay something to avoid such a waste of valuable societal assets. In any event, as described above, such an "agreement" between an owner and managers seems so unlikely that it is explainable only as a failure by the owner to understand the terms of the arrangement.

96. Professors Shleifer and Summers render a compelling description of the impact of a plant closing on remote constituencies. See Andrei Shleifer & Lawrence H. Summers, The Effect of Takeover Activity on Corporate Research and Development, in CORPORATE TAKEOVERS: CAUSES AND CONSEQUENCES 33-54 (Alan J. Auerbach ed., 1988). Return to text.

[97] This, of course, is merely a restatement of the often voiced criticism of Pareto standards: that Pareto criteria are nearly useless in the real world because it is impossible to avoid losers in transactions. See MURPHY & COLEMAN, supra note 24, at 186; POSNER, supra note 2, at 14. Return to text.

[98] Like Judge Calabresi, I generally am willing to pursue "goals that are apparently adhered to by most people in society, even if with no great consistency." Calabresi, supra note 19, at 556. Return to text.

[99] The examples in this section are intended to be more general and thus are primarily limited to money investors. In part V.C., human capital investors are considered specifically and, at that point, arguments are offered for the view that manifested societal values support the extension of the principles to human capital investors. Return to text.

[100] CLARK, supra note 81, at 678 (1986) ("[F]rom the traditional legal viewpoint, a corporation's directors and officers have a fiduciary duty to maximize shareholder wealth . . . ."); Dynamics Corp. of Am. v. CTS Corp., 794 F.2d 250, 256 (7th Cir.), rev'd, 481 U.S. 69 (1986) (Judge Posner states that a director's obligation is "stockholder wealth maximization."). Return to text.

[101] See, e.g., RMBCA § 7.40(a) (1994). But see WILLIAM CARY & MELVIN A. EISENBERG, CASES AND MATERIALS ON CORPORATIONS 936 & n.3 (1988) (stating that "a creditor . . . ordinarily has no right to bring a derivative action" but then stating in footnote three that "the rule is not entirely clear"). Return to text.

[102] Courts have developed derivative suit rules that protect creditors. For example, courts have been most reluctant to permit a pro rata recovery in a derivative action but, instead, have concluded that the full corporate loss must be awarded to the corporation. See HARRY G. HENN, HANDBOOK OF THE LAW OF CORPORATIONS § 373 (2d ed. 1970). One court explained the basis for the rule as follows:

One of the reasons why courts of equity have not allowed direct proportionate recoveries in stockholders' derivative suits has been that the recovery is an asset of the corporation, and its creditors have first claim upon it; and that to award such recovery direct to the stockholders leaving any creditors unpaid, would be fraudulent as to them.
Liken v. Shaffer, 64 F. Supp. 432, 441 (Iowa N.D. 1946). Return to text.

[103] See generally DANIEL R. COWANS, II BANKRUPTCY LAW AND PRACTICE 169-72 (6th ed. 1994). Return to text.

[104] See, e.g., MBCA § 45 (1991) (limiting payment of dividends to the amount of "earned surplus"). Even the RMBCA §§ 6.40 and 1.40(6) contain a similar, although significantly less restrictive, provision. Return to text.

[105] See, e.g., RMBCA § 6.40(c)(1) (1994). Return to text.

[106] See, e.g., UNIF. FRAUDULENT TRANSFER ACT, 7A U.L.A. 652 (1984); see generally Robert C. Clark, The Duties of the Corporate Debtor to its Creditors, 90 HARV. L. REV. 505 (1977). For an outstanding piece dealing with the problems of fraudulent conveyancing in the context of highly leveraged transactions, see Emily L. Sherwin, Creditors' Rights Against Participants in a Leveraged Buyout, 72 MINN. L. REV. 449 (1988). Return to text.

[107] Prior to the Bankruptcy Act Reform Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549 (1978) (codified as amended at 11 U.S.C. §§ 101-1330 (1978)), bondholders in a Chapter X reorganization were protected by the absolute priority rule, which required that the consideration they received in the reorganization be "fair and equitable." See, e.g., Walter J. Blum, The Law and Language of Corporate Reorganization, 17 U. CHI. L. REV. 565, 570-91 (1950). Although the 1978 Act changed the standard, it retained a limitation for the protection of bondholders. For an excellent discussion of this, see Victor Brudney, Corporate Bondholders and Debtor Opportunism: In Bad Times and Good, 105 HARV. L. REV. 1821, 1828-29 (1992). Return to text.

[108] Security Trust Indenture Act of 1939, 15 U.S.C. § 77 (1994) (providing that an indenture cannot, unless unanimous permission is granted, permit a rebargaining of the right to receive principal or interest, except that interest may be postponed for up to three years by approval of 75% of the principal amount). Return to text.

[109] See supra notes 61-65 and accompanying text. Return to text.

[110] See supra notes 59-60 and accompanying text. Return to text.

[111] Some may argue that certain of today's investors, such as employees and creditors, have been so abused by managers over the years that investors expect only the most aggressive and selfish conduct from managers. If, in fact, this is the case, society should be concerned. Return to text.

[112] Subjective expectations, of course, can be altered by more complete information, and thus one may be uneasy in defending a particular fiduciary formula by reference to such ephemeral expectations. As described earlier, however, informational asymmetries, contracting difficulties, and the nearly bizarre nature of the resulting arrangements among the parties should make one most suspicious of claims that investors accepted and priced no, or insignificant, fiduciary protections from managers. Return to text.

[113] See generally CLARK, supra note 81 (directors and officers have a fiduciary duty to maximize shareholder wealth); Dynamics Corp. of Am. v. CTS Corp., 794 F.2d 250, 256 (7th Cir.), rev'd, 481 U.S. 69 (1986) (directors' obligation is "stockholder wealth maximization"). Return to text.

[114] Obviously, managers have an economic incentive to expropriate the wealth of nonstockholders (and others). Regarding today's legal rules, it is an interesting question whether managers are free to expropriate nonstockholder value for themselves or are required by their fiduciary obligations to stockholders to turn over all such expropriations to stockholders. Return to text.

[115] The suggestion of the Contractarians to eliminate all fiduciary protections leaves the economic incentives unchanged, since in all events managers have economic incentives to create and exploit market failures for the benefit of themselves and voting stockholders. If, under a Contractarian regime, managers were to opt out of their fiduciary duties to stockholders, then managers' ability to construct and exploit market failures in furtherance of wealth transfers favorable to themselves and voting stockholders would be unconstrained by legal criteria. Return to text.

[116] Most of us, assumedly, reject the notion that any single value or goal must drive all decisions but, instead, believe that more than one value is worth promoting. This point is made by Murphy and Coleman as they contrast utilitarianism and Kantianism: "[B]oth traditions do . . . . seem highly plausible to most of us. We are inclined to think that each has an important perspective to offer on ethics, even if we are unsure of just how to integrate them both into one coherent overall moral vision." MURPHY & COLEMAN, supra note 24, at 79.

For example, many of us may believe that one's exercise of personal autonomy may entitle him or her to burn a building that he or she owns. Perhaps the act is a form of protest against an unjust war; perhaps the owner simply feels the building is too ugly to continue standing. If, however, the building contains a Van Gogh painting or the only copy of an unpublished Mozart sonata, which, let us assume, the owner is unwilling to sell at any price but intends to burn with the building, some may conclude that society has a right in such a case to intervene to prevent the owner from burning his or her building or the art work. Perhaps one may base such a restraint on utilitarian notions and conclude that the utility to the owner generated by burning the building and its contents is less that the loss of utility to society from the destruction of such a treasure. Perhaps we articulate the reasons for protecting art treasures differently, and perhaps we even conclude (I would not) that personal autonomy trumps in this case and that the owner may burn the building and the painting. The point is, however, that most of us in looking at the problem would not fail to see that values other than personal autonomy must at least be considered in arriving at a solution to the question. Return to text.

[117] Thomas R. Hurst & Larry J. McGuinness, The Corporation, The Bondholder and Fiduciary Duties, 10 J.L. & COM. 187, 205 (1991). Return to text.

[118] See, e.g., McDaniel, supra note 85, at 134 n.43 ("[M]anagers, acting as agents for all participants, can arrange cheaply, if not costlessly, for the necessary side payments."). Return to text.

[119] Managers faced with a prohibition against wealth transfers but nonetheless acting as rational maximizers normally would seem inclined to acquire the subsidiary described in the text, even if managers were not legally required to do so. Managers' self-interest prompts them to please common stockholders, because managers are appointed by common stockholders. Since stockholders would not be pleased if they were denied participation in the acquisition of the subsidiary, managers would take steps to complete the acquisition, which, in the face of a prohibition against wealth transfers, would require managers to eliminate the transfer of wealth away from creditors.

In certain instances, however, the interests of managers are aligned with creditors instead of common stockholders, see, e.g., Coffee, supra note 10, at 1519-21, necessitating an affirmative duty on managers that they convert a Kaldor-Hicks efficient move into a Pareto superior move instead of resisting the wealth-enhancing move on the grounds that the move also involves a wealth transfer. Consider, for example, a highly leveraged bid for a target, which bid may be wealth-enhancing as a total matter but at the same time, because of the new leverage, may depress the total value of the target's public debt. If managers were not required to convert a Kaldor-Hicks efficient move into a Pareto superior move, managers might, in their own self-interest, resist such a bid, since the successful bid may cost managers their jobs. See Marcel Kahan & Michael Klauser, Antitakeover Provisions in Bonds: Bondholder Protection or Management Entrenchment?, 40 UCLA L. REV. 931, 948-50 (1993) (pointing out that both managers and creditors may oppose a takeover, although managers oppose the takeover because of the potential loss of their jobs, while creditors oppose only the additional leverage).

Not only have commentators argued that at times managers' interests parallel interests of creditors, but also commentators have argued that managers' undiversified human capital investment in the corporation generates in managers a risk aversion that is more like that of creditors and thus less in line with the level of risk aversion of the common stockholders. As a result, managers may be disinclined to take on the additional debt in our hypothetical or to make the more risky investment, even if the investment increases the total value of the corporation. Regarding the risk aversion of managers, see Alison G. Anderson, Conflicts of Interest: Efficiency, Fairness and Corporate Structure, 25 UCLA L. REV. 738 (1977-78); Reiner H. Kraakman, Corporate Liability Strategies and the Cost of Legal Controls, 93 YALE L.J. 857 (1994). Return to text.

[120] Hurst & McGuinness, supra note 117, at 202-04. Return to text.

[121] See McDaniel, supra note 85, at 136 (recognizing the potential for controversy in rules governing the allocation of gains). Return to text.

[122] McDaniel says that Revlon v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), "suggests that stockholders must share in any division of net gains and further that any benefits received by other stakeholders must be 'rationally related' to the benefits received by stockholders." Id. at 135-36. Return to text.

[123] This is not to imply that the same rule regarding the discretion to allocate gain should apply at the intra-constituency level as applies at the inter-constituency level. Different considerations may exist in the two situations. A discussion of the obligation to share gains at the intra-constituency level is beyond the scope of this Article and accordingly left for another day. Return to text.

[124] Under the MBCA, stockholders dissenting from the terms of a merger, for example, were entitled to receive "fair value" for their stock, but such fair value excluded "any appreciation or depreciation in anticipation of such corporate action unless such exclusion would be inequitable." MBCA § 81(a)(3) (1991). The RMBCA uses essentially the same language. RMBCA § 13.01(3) (1994). Return to text.

[125] 406 F.2d 1112 (3d Cir. 1969). Return to text.

[126] Id. at 1117. Return to text.

[127] 552 F.2d 1239 (7th Cir.), cert. denied, 434 U.S. 922, reh'g denied, 434 U.S. 1002 (1977). Return to text.

[128] McDaniel, whose work is both admirable and compelling, suggests a requirement that gains be shared with bondholders, although he states that "[a]n equal division of gain between bondholders and stockholders per dollar invested would lack a rational basis because a firm's stock is relatively more risky than its bonds." See McDaniel, supra note 58, at 257. He suggests a permissive allocation of gains to other constituencies. See McDaniel, supra note 85, at 136. Return to text.

[129] Requiring managers to allocate gains according to such a formula is much more complex than requiring managers to avoid wealth transfers. For example, moves by managers that decrease the value of creditors' investments in the company can be identified by reference to the market, either an external and active market or an inferred market. McDaniel also finds that a determination "of Pareto efficiency between bondholders and stockholders is a far simpler task" than allocating gains between the two constituencies. He believes that the "stock market and bond market provide ready answers" to the question of whether a move was Pareto superior. McDaniel, supra note 58, at 257. Return to text.

[130] The proposal of permitting managers to allocate gains is based to a significant degree on inferred consent. I am prepared to infer that fixed claimants manifest only the most limited expectations to share in corporate gains. By selecting an investment with a fixed return, such investors consent not to share in corporate gains, at least not to any significant degree. Regarding consent as a moral justification, see generally Posner, supra note 18. Return to text.

[131] McDaniel disagrees. Because "in bad times stakeholders must share in the losses," he reasons that "in good times stakeholders should be able to share in the gains." McDaniel supra note 85, at 135. Return to text.

[132] Obviously, such transactions are also encouraged by the Principle Requiring Corporate Value Maximization, which requires managers to make all moves that increase the value of the corporation. See Frank H. Easterbrook & Daniel R. Fischel, Corporate Control Transactions, 91 YALE L.J. 698, 710 (1982). Return to text.

[133] The greatest incentive for value-maximizing transactions, of course, would come if the respective decisionmaker were allowed to keep all the gain. This proposition leads to the notion that managers should be able to keep all corporate gains, an idea I reject because it conflicts so fundamentally with the fiduciary concept. Return to text.

[134] No reason exists to fear that managers generally will allocate inappropriate amounts of gain to constituencies other than common stockholders, although such fears have been voiced. See McDaniel, supra note 85, at 136.

The point made by commentators, that the interests of managers are often more aligned with creditors than stockholders, does not lead to a conclusion that unfettered managers will allocate gains to bondholders. While such an alignment of interests may affect investment decisions (managers and creditors tend to be more risk-averse than shareholders, and thus managers may make investment decisions more agreeable to bondholders than stockholders) and decisions regarding defensive tactics (managers and creditors may consider it to be in their best interests to resist highly leveraged acquisitions of the company, even if the acquisition is in the best interests of stockholders), such ephemeral alignments provide no incentives for managers to allocate gains to bondholders, for example. See generally supra notes 125-27 and accompanying text. Return to text.

[135] The rule is long-standing that creditors generally have no right to enforce directly management's fiduciary obligations. See, e.g, HENRY W. BALLANTINE, CORPORATIONS 184 (rev. ed. 1946) ("Creditors have no direct right of action against directors or officers for mismanagement . . . by the better view."). Examples of cases supporting this position include Nuclear Corp. of Am. v. Hale, 355 F. Supp. 193 (Tex. N.D. 1973); Skinner v. Hulsey, 138 So. 769 (Fla. 1931); Confick v. Houston Civic Opera Ass'n, 99 S.W.2d 382, 385 (Tex. 1936) ("Directors are not personally liable to creditors for mismanagement, or for waste of assets except on proof of the commission of such fraud."); Equitable Life & Cas. Ins. Co. v. Inland Printing Co., 484 P.2d 162 (Utah 1971); Anderson v. Bundy, 171 S.E. 501 (Va. 1933); Wheeling Kitchen Equip. Co. v. R. & R. Sewing Center, Inc., 179 S.E.2d 587 (W. Va. 1971); Inter-Ocean Cas. Co. v. Lecony Smokeless Fuel Co., 17 S.E.2d 51 (W. Va. 1941). See also the cases cited in RALPH J. BAKER & WILLIAM L. CARY, CASES AND MATERIALS ON CORPORATIONS 610 (3d ed. 1959).

Similarly, creditors generally have not been permitted to enforce fiduciary claims against management derivatively in the right of the corporation. See, e.g., RMBCA § 7.41(a) (1994) (predicating the right to institute a derivative suit on one's having been a "shareholder of the corporation when the transaction complained of occurred"). A similar position is taken in AMERICAN LAW INSTITUTE, II PRINCIPLES OF CORPORATE GOVERNANCE § 7.02 (1994). Again, this is a long-standing general rule. See BALLANTINE, supra, at 351.

Courts have used various reasons for not extending fiduciary protection to creditors, reasons including that management is not a trustee for creditors, Skinner, 138 So. at 770 ("It is difficult to perceive upon what principle a director of a corporation can be considered a trustee of its creditors."); Whitfield v. Kern, 192 A. 48, 55 (N.J. 1937) (stating that management is not the agent for creditors). Return to text.

[136] See, e.g., Swinney v. Keebler Corp., 329 F. Supp. 216 (D.S.C. 1971). Swinney is one of the most intriguing, and the most overlooked, of the cases indicating that corporate managers owe fiduciary duties to creditors. Although the Fourth Circuit reversed the lower court's holding that creditors could recover for the breach of fiduciary duties, Swinney v. Keebler Corp., 480 F.2d 573 (4th Cir. 1973), the reversal was based on the appellate court's determination that the fiduciary had acted reasonably in the circumstances. The appellate court did not reject the right of creditors to enforce fiduciary obligations and stated that "if the sellers of control are in a position to foresee the likelihood of fraud on the corporation, including its creditors . . . or on the remaining stockholders, at the hands of the transferee, their fiduciary duty imposes a positive duty to investigate. . . ." Id. at 578 (citations omitted). Other cases indicating that creditors may be owed some sort of fiduciary duty include Pepper v. Litton, 308 U.S. 295 (1939); United States v. AT&T, 552 F. Supp. 131 (D.D.C. 1982), aff'd mem. sub nom Maryland v. United States, 460 U.S. 1001 (1983); Francis v. United Jersey Bank, 432 A.2d 814 (N.J. 1981); Western Producers Coop. v. Great Western United Corp., 613 P.2d 873 (Colo. 1980); Steinberg v. Blaine, 17 S.W.2d 286, 288 (Ark. 1929); Johnson v. Coleman, 20 S.W.2d 186 (Ark. 1929); Anthony v. Jeffress, 90 S.E. 414 (N.C. 1916); W. H. Elliot & Sons Co. v. Gotthardt, 305 F.2d 544 (1st Cir. 1962); Goodwin v. Whitener, 138 S.E.2d 232 (N.C. 1964); Ford Motor Credit Co. v. Minges, 473 F.2d 918 (4th Cir. 1973) (applying North Carolina law); Underwood v. Stafford, 155 S.E.2d 211 (N.C. 1967). Clearly, however, the substantial majority rule is that creditors are owed no fiduciary duties. See, e.g., Pittsburgh Terminal Corp. v. Baltimore & O.R.R. Co., 680 F.2d 933, 941 (3d Cir.), cert. denied, 459 U.S. 1056 (1982); Harff v. Kerkorian, 324 A.2d 215 (Del Ch. 1974), rev'd on other grounds, 347 A.2d 133 (Del. 1975). Professor Mitchell correctly states that "scholars supporting expanded bondholder rights do not have a great deal of law supporting them." Mitchell, supra note 46, at 1169 n.11. Return to text.

[137] See Rutheford B. Campbell Jr., Limited Liability for Corporate Shareholders: Myth or Matter-of-Fact, 63 KY. L.J. 23, 55-71 (1975). Return to text.

[138] See generally Albert H. Barkey, The Financial Articulation of a Fiduciary Duty to Bondholders with Fiduciary Duties to Stockholders of the Corporation, 20 CREIGHTON L. REV. 47 (1986); William W. Bratton Jr., Corporate Debt Relationships: Legal Theory in a Time of Restructuring, 1989 DUKE L.J. 92; Hurst & McGuinness, supra note 117; Morey W. McDaniel, Bondholders and Corporate Governance, 41 BUS. LAW. 413 (1986); McDaniel, supra note 58; Mitchell, supra note 46. The thinking in this area has been helped by works on closely related subjects. See, e.g., James J. Hanks, Playing with Fire: Nonshareholder Constituency Statutes in the 1990s, 21 STETSON L. REV. 97 (1991); Kahan & Klausner, supra note 119; McDaniel, supra note 85 (arguing for the use of Pareto concepts in interpreting constituency statutes); Jonathan R. Macey, An Economic Analysis of the Various Rationales for Making Shareholders the Exclusive Beneficiaries of Corporate Fiduciary Duties, 21 STETSON L. REV. 23 (1991). Return to text.

[139] Two authors report that more than 230 companies were involved in "event risk" transactions between 1984 and 1989. Hurst & McGuinness, supra note 117, at 190 n.14. The authors defined "event risk" transactions as "corporate activity which results in a downgrading of the credit rating of corporate debt obligations." This includes leveraged buyouts. Id. at n.15. Two other authors report that from 1984 through 1988, the bonds of 183 companies "lost value as a result of mergers, acquisitions or leveraged buyouts." Kahan & Klauser, supra note 119, at 933 n.2. Return to text.

[140] Probably the most famous of the cases continues to be the RJR Nabisco acquisition. See Deborah A. DeMott, Introduction—The Biggest Deal Ever, 1989 DUKE L.J. 1. Return to text.

[141] Kahan & Klauser, supra note 119, at 933 ("[L]everaged acquisitions and recapitalizations transformed blue-chip bonds valued in the tens of billions of dollars into speculative-grade 'junk'."); Hurst & McGuinness, supra note 117, at 187-91. McDaniel refers to the losses of bondholders as "possibly the largest expropriation of investors in American business history." MacDaniel, supra note 58, at 206. At least some commentators characterize these transactions as wealth transfers. See, e.g., McDaniel, supra note 85, at 124; Coffee, supra note 10, at 1498. Return to text.

[142] James Sterngold, Kohlberg Leads Latest Nabisco Bids, N.Y. TIMES, Nov. 30, 1988, at D1; see generally DeMott, supra note 146. Return to text.

[143] Bernard Black & Joseph A. Grundfest, Shareholder Gains from Takeovers and Restructurings Between 1981 and 1986: $162 Billion Is a Lot of Money, J. APPLIED CORP. FIN. 5 (Spr. 1988) (estimating that stockholder wealth increased $162 billion during the period as a result of takeovers); see also Greg A. Jarrell et al., The Market for Corporate Control: The Empirical Evidence Since 1980, 2 J. ECON. PERSP. 49, 51-53 (1988) (citing studies regarding shareholder gains in takeovers). Return to text.

[144] See the results of studies reported in Kahn & Klauser, supra note 119, at 940 ("Studies show that the gains to shareholders from both hostile and friendly acquisitions, on average, far exceed losses to bondholders."); see also Coffee, supra note 10, at 1515-1521. Return to text.

[145] In economic terms, this result should not be surprising since the result indicates that common stockholders were able to expropriate value from other constituencies and appropriate some or all of the value of efficiency gains generated by the transaction. Return to text.

[146] See supra notes 104-08 and accompanying text. Return to text.

[147] The similarity in the positions of debtholders and equityholders was recognized years ago by scholars. See ADOLPH A. BERLE, JR., STUDIES IN THE LAW OF CORPORATION FINANCE 156 (1928); Jerome Frank, Adolph A. Berle's The Modern Corporation and Private Property, 42 YALE L.J. 989, 992 (1933) (book review); ARTHUR S. DEWING, THE FINANCIAL POLICY OF CORPORATIONS 166-67 (5th ed. 1953).

More recently, Easterbrook and Fischel opined regarding the similarity of debt and equity. See Frank H. Easterbrook & Daniel F. Fischel, Close Corporations and Agency Costs, 38 STAN. L. REV. 271, 274 n.8 (1986) (noting "no fundamental difference between debt and equity claims from an economic perspective"); see also William H. Bratton, Corporate Debt Relationships: Legal Theory in a Time of Restructuring, 1989 DUKE L.J. 92, 114-16; Campbell, supra note 137, at 64-67; McDaniel, supra note 58, at 218-21. Professor Mitchell seems to agree that bondholders and stockholders are generally in similar circumstances, but he would shape fiduciary obligations to bondholders as a function of whether the situation involves a "vertical relationship" or a "horizontal relationship." Mitchell, supra note 46, at 1180-89. But see Hurst & McGuinness, supra note 117, at 191-92 (outlining the "investment theory," but opining that "the legitimate expectations of the two groups of security holders differ significantly"). Return to text.

[148] On average, one may assume that those purchasing debt from issuers in private transactions are better able to protect themselves through bargaining than are those who purchase debt from issuers in public offerings. Typically, such private purchasers have more access to information, have more at stake, and are more sophisticated than are public purchasers. See Brudney, supra note 106, at 1830-31. Brudney points out, however, that not all private purchasers of debt are on equal footing. See Brudney, supra note 107, 1830 n.20. The same, of course, is true with regard to purchasers of publicly issued and privately issued equity. McDaniel argues that one of the important changes in the bond market in recent years is the "significant participation by individual investors. The bond market no longer is (if it ever was) the exclusive domain of institutional investors able to fend for themselves." McDaniel, supra note 138, at 415. Return to text.

[149] See Mitchell, supra note 46, at 1183; Bratton, supra note 147, at 156 (dealing with debt offerings); see also Eisenberg, supra note 6, at 1518-19 (dealing with equity issues). Return to text.

[150] See, e.g., Brudney, supra note 107, at 1830-31; Mitchell, supra note 46, at 1183; McDaniel, supra note 138, at 429-31. Return to text.

[151] See William W. Batton, The Economics and Jurisprudence of Convertible Bonds, 84 WIS. L. REV. 667, 715 (1984) (discussing the inability of bond purchasers to protect themselves through the bargaining process); Brudney, supra note 107, at 1830 & n.20 (discussing the especially disadvantaged position of purchasers of publicly issued debt and citing authority for the argument that "the substantial erosion of protective covenants in publicly issued bonds after 1970 was not readily appreciated by investors or digested by the market until debtors made that erosion apparent in the mid-1980s"); Mitchell, supra note 46, at 1181-86 (discussing the structural bases for market failures in the sale of debt instruments). But see Kahn & Klausner, supra note 119, at 981 ("Our findings are inconsistent with those commentators who claim that bondholders cannot obtain effective contractual protection."); Jonathan R. Macey, Externalities, Firm-Specific Capital Investments, and the Legal Treatment of Fundamental Corporate Changes, 1989 DUKE L.J. 173, 182 (Purchasers of fixed corporate claims "will . . . adjust the price they pay for their fixed claims to compensate themselves for the prospect that shareholders will make subsequent wealth transfers."); Ronald Daniels, Stakeholders and Takeovers: Can Contractarianism Be Compassionate?, 43 TORONTO L.J. 315, 344-45 (1993) (finding that creditors are adequately protected by the market and their ability to bargain). Return to text.

[152] See supra note 119 and accompanying text. Return to text.

[153] See, e.g., Macey, supra note 151, at 182. Return to text.

[154] See, e.g., McDaniel, supra note 138, at 433-34. Return to text.

[155] Regarding the risk aversion of managers, see Allison G. Anderson, Conflicts of Interest: Efficiency, Fairness and Corporate Structure, 25 UCLA L. REV. 738, 785 n.141 (1978); cf. Reinier H. Kraakman, Corporate Liability Strategies and the Cost of Legal Controls, 93 YALE L.J. 857, 862-64 (1984).

Jensen and Meckling liken managers' salary claims to a quasi-debt. See Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. FIN. ECON. 305, 353-54 (1976). Return to text.

[156] Coffee, supra note 10, at 1519-21. Return to text.

[157] See supra note 119 and accompanying text. Return to text.

[158] McDaniel, supra, note 138, at 434 ("A company with a reputation for hurting its bondholders will find it more difficult to sell bonds in the future."). Return to text.

[159] For descriptions of this argument, see Hurst & McGuinness, supra note 117, at 197; McDaniel, supra note 58, at 238. See also John Kose & David C. Nachman, Risky Debt, Investment Incentives and Reputation in a Sequential Equilibrium, 40 J. FIN. 863, 876 (1985); Ileen Malitz, On Financial Contracting: The Determinants of Bond Covenants, 1986 15 FIN. MGMT. 18, 24-25. Return to text.

[160] Karl N. Llewellyn, What Price Contract?—An Essay in Perspective, 40 YALE L.J. 704, 722 (1931). Return to text.

[161] With regard to the recent highly leveraged transactions and the impact on bondholders, Professor Coffee concluded: "[H]aving convinced bondholders to delete most negative covenants for reasons that seem plausibly in their mutual self-interest, managements have exploited that trust when faced with shareholder pressures that might otherwise result in their ouster." Coffee, supra note 10, at 1515. Return to text.

[162] Both Hurst and McGuinness, and McDaniel agree. See Hurst & McGuiness, supra note 117, at 198 (It "appears that the bondholders' reliance on the reputational capital of major corporations . . . was misplaced."); McDaniel, supra note 58, at 238 ("When covenants are incomplete and the company is in extremis, reputation does not fill the gap."). Return to text.

[163] Commentators have made strong claims about the pervasiveness of the benefits of the market for corporate control. For example, to counter the late Professor Cary's argument that the states are in a "race for the bottom" in which they each compete for corporate charters by minimizing investor protection, see William L. Cary, Federalism and Corporate Law: Reflections upon Delaware, 88 YALE L.J. 663 (1974), some commentators argued that the competition for corporate control neutralizes the harmful impact of such competition, see Ralph K. Winter, State Law, Shareholder Protection, and the Theory of the Corporation, 6 J. LEGAL STUD. 251 (1977). Return to text.

[164] Easterbrook & Fischel, supra note 48, at 1169-74 (1981); Kahan & Klausner, supra note 138, at 944; Henry G. Manne, Mergers and the Market for Corporate Control, 73 J. POL. ECON. 110, 113 (1965). Return to text.

[165] Dean Prunty's work on the origins of the derivative suit lends support for the appropriateness of permitting creditors to enforce rights through a derivative action. See Bert S. Prunty, The Shareholders Derivative Suit: Notes on its Derivation, 32 N.Y.U. L. REV. 980, 992, 994 (1957) ("[T]he origin of the derivative suit . . . lies in judicial recognition of a new wrong or maladjustment for which pre-existing legal procedures proved more or less inadequate." The derivative suit "was born and nurtured as a corrective for managerial abuse in economic units which by their nature deprived some participants of an effective voice in their administration.").

Professors Coffee and Schwartz, however, argue against permitting creditors to institute derivative suits on the grounds that such a change would chill socially useful risk taking. See John C. Coffee & Donald E. Schwartz, The Survival of the Derivative Suit: An Evaluation and a Proposal for Legislative Reform, 81 COLUM. L. REV. 261, 313 n.277 (1981). Return to text.

[166] As previously discussed, creditors presently have no right to enforce claims through derivative actions. See supra notes 135-38 and accompanying text. Return to text.

[167] In administering derivative suits, courts have developed rules that protect creditors. See supra note 102 and accompanying text. Return to text.

[168] Presenting this position powerfully, Professor Epstein imagines as facts employees with the capability to understand employment arrangements ("we are dealing with the routine stuff of ordinary life; people who are competent enough to marry, vote, and pray are not unable to protect themselves in their day-to-day business transactions") and who, in fact, generally understand their employment arrangements ("nor is there any reason to believe that such contracts are marred by misapprehensions, since employers and employees know the footing on which they have contracted"). Epstein, In Defense, supra note 28, at 954-55. Such facts, of course, are essential to the Contractarians' position. See Daniels, supra note 39, at 327. Return to text.

[169] Epstein, In Defense, supra note 28, at 954. Professor Macey is less assertive factually, although he arrives at the same result. He concludes that employees do make investments in firms and are subject to expropriation but that, nonetheless, matters are best left to private arrangements. Macey, supra note 157, at 176, 188-92, 200-01. Return to text.

[170] Epstein, In Defense, supra note 28, at 953-55. Return to text.

[171] This is the same argument proffered regarding the expropriation of creditors' value. Specifically, Contractarians argue that the corporation will not expropriate creditors' value because it raises the corporation's future cost of capital. See supra notes 158-62 and accompanying text. Return to text.

[172] See, e.g., Clive Bull, The Existence of Self-Enforcing Implicit Contracts, 102 Q.J. OF ECON. 147, 149-54 (1987). Return to text.

[173] Macey, supra note 151, at 192 ("employer's need to maintain its reputation in the community and to attract new workers in the future will tend to discourage exploitation"); Epstein, In Defense, supra note 28, at 967-68, 970, 974. Return to text.

[174] See OLIVER E. WILLIAMSON, THE ECONOMIC INSTITUTIONS OF CAPITALISM 259-61 (1985); William J. Carney, Does Defining Constituencies Matter?, 59 U. CIN. L. REV. 385, 405-12 (1990); Costas Azariadis & Joseph E. Stiglitz, Implicit Contracts and Fixed Price Equilibria, 98 Q.J. ECON. 1, 15-19 (Supp. 1983). Return to text.

[175] For a description of these arguments, see Daniels, supra note 39, at 336-40. Return to text.

[176] See, e.g., Joseph W. Singer, The Reliance Interest in Property, 40 STAN. L. REV. 611, 621 (1988); Clyde W. Summers, Labor Law as the Century Turns: A Changing of the Guard, 67 NEB. L. REV. 7, 15-16 (1988); David Millon, Redefining Corporate Law, 24 IND. L. REV. 223, 234-35 (1991). Return to text.

[177] Recent scholarship arguing that employee investments of human capital necessitate extra-contractual protection for the investing employees includes Stone, Employees as Stakeholders, supra note 76, at 48 ("[E]mployees' interests should be protected from major corporate restructuring decisions that threaten to expropriate those investments."), and O'Connor, supra note 75. Return to text.

[178] See, e.g., GARY S. BECKER, HUMAN CAPITAL: A THEORETICAL AND EMPIRICAL ANALYSIS WITH SPECIAL REFERENCE TO EDUCATION l29-30 (1993); MASAHIKO AOKI, THE CO-OPERATIVE GAME THEORY OF THE FIRM 14 (3d ed. 1984); Bull, supra note 172, at 658. For a graphic illustration of this theory, see Michael L. Wachter & George M. Cohen, The Law and Economics of Collective Bargaining: An Introduction and Application to the Problems of Subcontracting, Partial Closure and Relocation, 136 U. PA. L. REV. 1349, 1362 (1988). Return to text.

[179] The theory is well explained by Stone in Policing, supra note 76, at 363-69; Stone, Employees as Stakeholders, supra note 76, at 48-53. See also O'Connor, supra note 75, at 1205-07. Return to text.

[180] For descriptions of these risks, see Stone, Policing, supra note 76, at 369; Stone, Employees as Stakeholders, supra note 76, at 52; and O'Connor, supra note 75, at 1208-10.

Interestingly, Judge Posner offers a similar analysis as an economic explanation for age discrimination laws. See POSNER, supra note 2, at 339. Return to text.

[181] See Shleifer & Summers, supra note 96. Oliver Hart, however, after suggesting that such a line of argument may justify defensive tactics by management, finds the entire argument difficult to sort out. He finds it difficult to determine whether the high wages of employees before a takeover are a function of past service or "the result of managerial slack or the price management has paid for an easy life." He fears, as a result, the throttling of "efficiency-enhancing bids." Oliver Hart, An Economist's View of Fiduciary Duty, 43 U. TORONTO. L.J. 299, 312 (1993). Return to text.

[182] Not all scholars accept the fact that employees invest in the firm by underpricing their services during part of their careers. See, e.g., Boyan Jovanovic, Job Matching and the Theory of Turnover, 87 J. POL. ECON. 972, 973 (1979). Even advocates of protection for employees concede that the empirical evidence is inconclusive on this matter. See Stone, Employees as Stakeholders, supra note 76. Return to text.

[183] See Stone, Employees as Stakeholders, supra note 76, at 64-74. Return to text.

[184] Not surprisingly, a similar view is expressed by Professor Clyde Summers:

[E]mployees who provide the labor [for corporations] are as much members of that enterprise as the shareholders who provide the capital. Indeed, the employees may have made a greater investment in the enterprise by their years of services, may have much less ability to withdraw, and may have a greater stake in the future of the enterprise than many of the stockholders.
Clyde W. Summers, Codetermination in the United States: A Projection of Problems and Potential, 4. J. OF COMP. CORP. L. & SCI. REG. 155, 170 (1982). Aoki similarly states that "employees form an integral part of the firm for which they work to a far greater extent than shareholders." AOKI, supra note 178. It has also been pointed out that harm to employees of firms may have significant, indirect adverse impacts on other groups. See, e.g., Peter E. Millspaugh, Plant Closings and the Prospects for a Judicial Response, 8 J. CORP. L. 483, 484-86 (1983). Return to text.

[185] See infra notes 204-10 and accompanying text. Return to text.

[186] See, e.g., John C. Coffee Jr., The Uncertain Case for Takeover Reform: An Essay on Stockholders, Stakeholders and Bust-Ups, WIS. L. REV. 435, 448 (1988); Hart, supra note 181, at 303 (noting that it is "hard to write a contract that specifically rules out all the possible bad actions that management might undertake"). Not all agree that this is a basis for interfering with free contracting. Professor Williamson, for example, concedes the inability to anticipate all possible conditions but argues that the market will adjust in the next case. Oliver Williamson, Corporate Governance, 93 YALE L.J. 1197, 1197-1202 (1984). Return to text.

[187] O'Connor, supra note 75, at 1241. Return to text.

[188] See Duncan Kennedy, Distributive and Paternalistic Motives in Contract and Tort Law, with Special Reference to Compulsory Terms and Unequal Bargaining Power, 41 MD. L. REV. 563, 630 (1982). Return to text.

[189] For example, Professor Stone makes the point that a collective bargaining agreement in which X corporation agrees to pay all employees the fair value of their human capital investment in the event that they are terminated without cause would be unenforceable against a firm that acquired the assets of X and may be unenforceable against a firm that acquired X in a statutory merger. See Katherine Van Wezel Stone, Labor and the Corporate Structure: Changing Conceptions and Emerging Possibilities, 55 U. CHI. L. REV. 73, 102-11 (1988); Stone, Employees as Stakeholders, supra note 76, at 62. Return to text.

[190] Carl Shapiro & Joseph E. Stiglitz, Equilibrium Unemployment as a Worker Discipline Device, 74 AM. ECON. REV. 433, 442 (1984); Stone, Policing, supra note 76, at 371; Clyde W. Summers, Individual Protection Against Unjust Dismissal: Time for a Statute, 62 VA. L. REV. 481, 520 (1976); Lawrence E. Blades, Employment at Will v. Individual Freedom: On Limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404, 1412-13 (1967); Clive Bull, The Existence of Self-Enforcing Implicit Contracts, 102 Q.J. ECON. 147, 148 (1987); Shleifer & Summers, supra note 96, at 39; Stone, Employees as Stakeholders, supra note 76, at 55 ("[I]n large and widely dispersed labor markets, reputational factors are often inadequate to the task" of protecting against opportunistic breaches). Return to text.

[191] For some interesting evidence regarding abusive employer conduct, see Summers, supra note 184, at 507, 532 (citing an American Association of Arbitrators study that shows more than one-half of discharge cases resulted in employee reinstatement and reports the arbitration of "tens of thousands of discipline cases, finding nearly half to be instances of injustice"). Return to text.

[192] See, e.g., Coffee, supra note 75, at 78-79. Return to text.

[193] For a description of modern portfolio theory, see RICHARD A. BREALEY, AN INTRODUCTION TO RISK AND RETURN FROM COMMON STOCKS, 42-46, 48-54, 115-31 (1969). Return to text.

[194] Such a picture is painted, for example, in Summer, supra note 184; Lawrence E. Blades, Employment at Will v. Individual Freedom: On Limiting the Abusive Exercise of Employer Power, 67 COLUM. L. REV. 1404, 1404-10 (1967). Return to text.

[195] See, e.g., Macey, supra note 138, at 37-38 (1991). Return to text.

[196] See generally POSNER, supra note 2, at 101-05. Applied to the area of fundamental corporate change, for example, rules designed to protect stakeholders merely "rearrange" the relationships, suggests Macey. Macey, supra note 151, at 180. Return to text.

[197] 29 U.S.C.A. § 201 (West 1994). Return to text.

[198] Id. § 651. Return to text.

[199] Id. § 212. Return to text.

[200] E.g., CONN. GEN. STAT. § 31-0 (1994). Return to text.

[201] 1988 Worker Adjustment and Retraining Notification Act, 29 U.S.C. §§ 2101-09 (1994). Return to text.

[202] HAW. REV. STAT. §§ 394B-9 to -10 (Supp. 1994); ME. REV. STAT. ANN. tit 26, § 625-B (West 1994). Return to text.

[203] Professor Stone refers to "the widely held intuition" regarding the unfairness of laying off "employees who have substantial seniority without some form of warning, severance pay, and pension protection." Stone, Employees as Stakeholders, supra note 76, at 52. Return to text.

[204] Regarding the difficulties of calculating the value of human capital investment by employees, see Stone, Employees as Stakeholders, supra note 76, at 50-51. Perhaps an even more pessimistic picture of evaluation difficulties is disclosed as Professor Stone attempts to fashion a "tin parachute" pay provision that approximates an appropriate payout for the loss of employees' human capital investment in the firm. Id. at 59-60. Professor Macey concludes that it would be difficult to calculate and award appropriate specific capital to dismissed employees. Macey, supra note 151, at 193. Return to text.

[205] Professor Epstein uses a similar argument in support of the employment-at-will doctrine and against a rule requiring cause for dismissal of employees. Epstein, In Defense, supra note 28, at 953. Return to text.

[206] O'Connor, supra note 75, at 1207. A similar view is expressed in Edward N. Gamber, Long-Term Risk-Sharing Wage Contracts in an Economy Subject to Permanent and Temporary Shocks, 6 J. LAB. ECON. 83, 84 (1988). Return to text.

[207] Larry Samuelson, Implicit Contracts with Heterogeneous Labor, 3 J. LAB. ECON. 70, 87 (1985). Return to text.

[208] One commentator sympathetic to the claim of expropriation of human capital investments nonetheless rejects solutions that would make firms "reluctant to reduce their work forces . . . for legitimate, market-driven reasons . . . ." The author fears that it would "deprive troubled firms of flexibility to restructure their costs, thereby hastening firm failure." Stone, Employees as Stakeholders, supra note 76, at 62. The author fears that it would "deprive troubled firms of flexibility to restructure their costs, thereby hastening firm failure." Id. Return to text.

[209] Contractarians, for example, argue that imposing mandatory terms will not change the level of benefits to employees, only the form of the compensation. See supra note 295 and accompanying text. Return to text.

[210] One may argue against ensuring payment in full of the present value of an employee's human capital investment on the grounds that it would create perverse incentives and a moral hazard, since employees protected by such rights "might be tempted to shirk in order to provoke a staff reduction." Stone, Employees as Stakeholders, supra note 76, at 60. The argument is unpersuasive, however, if employees' claims are limited to the present value of their "firm specific capital." Such a limitation on recovery is not only consistent with the implied contract theory but also would seem to reduce significantly an employee's incentive to cause a staff reduction, since if employees shirk, they risk losing the income stream from their future employment, which is the same risk that is thought to inspire all workers. Return to text.

[211] 506 A.2d 173 (Del. 1986). Return to text.

[212] The court went on to state: "The directors' role changed from defenders of the corporate bastion to auctioneers, charged with getting the best price for the stockholders at a sale of the company." Id. at 182. Return to text.

[213] Not surprisingly, the Delaware courts have been forced to deal with the question of when the Revlon duties become applicable. Mills Acquisition Co. v. MacMillian, Inc., 559 A.2d 1261 (Del. 1989); Paramount Communications, Inc. v. Time Inc., 571 A.2d 1140 (Del. 1989); Paramount Communications Inc. v. QVC Network, Inc., 637 A.2d 34 (Del. 1994) (all indicating that Revlon duties attach not only when the target is faced with a bust-up but also when the target is faced with a change in control). Return to text.

[214] See supra note 156 and accompanying text. Return to text.

[215] At least two other arguments support elimination of any special Revlon duties. First, investors harbor legitimate expectations that managers will act at all times to maximize the value of the corporation. See supra text accompanying notes 103-10. Additionally, an economic argument supports elimination of special Revlon duties through the broad application of the Principle Requiring Corporate Value Maximization. Already, courts (and thus litigants and their attorneys) have spent significant resources litigating the question of whether facts support the application of the special Revlon duties. See, e.g., Mills Acquisition Co., 559 A.2d at 1261; Paramount Communications, Inc., 571 A.2d at 1140; QVC Network, 637 A.2d at 34. The expenses of dealing with these issues, both at the stage where managers make decisions and at the litigation stage, would be eliminated by the broad application of the Principle Requiring Corporate Value Maximization. Return to text.

[216] As with the application of the Principle Requiring Corporate Value Maximization, the application of the Principle Prohibiting Wealth Transfers in such situations would facilitate clarity. For example, in Revlon, the court stated that in responding to an unsolicited bid, consideration of the interests of corporate constituencies other than stockholders "may be permissible," but apparently only in instances where such actions "are rationally related [to] benefits accruing to the stockholders." 506 A.2d at 182. The court then stated: "However, such concern for non-stockholder interests is inappropriate when an auction among active bidders is in progress, and the object no longer is to protect or maintain the corporate enterprise but to sell it to the highest bidder." Id. Obviously, such language is confusing but seems to indicate that when the corporation is sold, the fiduciary duty of managers is to expropriate as much wealth from nonstockholders as possible. Return to text.

[217] Charles W. Murdock, The Evolution of Effective Remedies for Minority Shareholders and Its Impact on Valuation of Minority Shares, 65 NOTRE DAME L. REV. 425, 478 (1990); J.A.C. Hetherington & Michael P. Dooley, Illiquidity and Exploitation: A Proposed Statutory Solution to the Remaining Close Corporation Problem, 63 VA. L. REV. 1, 5 (1977). Return to text.

[218] Victor Brudney, Equal Treatment of Shareholders in Corporate Distributions and Reorganizations, 71 CAL. L. REV. 1073, 1099 (1983); Theodore N. Mirvis, Two-Tier Pricing: Some Appraisal and "Entire Fairness" Valuation Issues, 38 BUS. LAW. 485, 489 (1982-83); Carole B. Silver, Fair Dealing Comes of Age in the Regulation of Going Private Transactions, 9 J. CORP. L. 385, 396 (1983-84). Return to text.

[219] See, e.g., Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983). Return to text.

[220] See, e.g., RMBCA § 12.01(3) and 13.02 (1994). Return to text.

[221] Cases involving valuation of minority interests in a corporation include Kalabogias v. Georgiou, 627 N.E.2d 51, 57 (Ill. 1993); Dermody v. Sticco, 465 A.2d 948, 951 (N.J. 1983); Weinberger v. UOP, Inc., 426 A.2d 1333, 1356 (Del. 1981); Citron v. E.I. Du Pont de Nemours & Co., 584 A.2d 490, 507 (Del. 1990); In re Valuation of Common Stock of Libby, McNeil & Libby, 406 A.2d 54, 61 (Me. 1979). Return to text.

[222] See Sanders v. Cuba R.R. Co., 120 A.2d 849 (N.J. 1956); Agnew v. American Ice Co., 61 A.2d 154 (N.J. Super. Ct. Ch. Div. 1948); Day v. United States Cast Iron Pipe & Foundry Co., 123 A. 546, aff'd, 126 A. 302 (N.J. 1924) (the court was equally divided). Other courts rejected the dividend credit rule. See Wabash Ry. Co. v. Barclay, 280 U.S. 197 (1930); Guttmann v. Illinois Cent. R.R. Co., 189 F.2d. 927 (2d Cir. 1951), cert. denied, 342 U.S. 867 (1952). Return to text.

[223] See Adolph A. Berle, Jr., Noncumulative Preferred Stock, 23 COLUM. L. REV. 358 (1923); Norman D. Lattin, Noncumulative Preferred Stock, 25 ILL. L. REV. 148 (1930); Alexander H. Frey, The Distribution of Corporate Dividends, 89 U. PA. L. REV. 735 (1941); Note, Dividend Rights of Noncumulative Preferred Stock, 61 YALE L.J. 245 (1952); Note, Right of Noncumulative Preferred Stockholders to Back Dividends Earned but Unpaid, 74 U. PA. L. REV. 605 (1926). Return to text.

[224] An interesting twist on this is Baron v. Allied Artists Pictures Corp., 337 A.2d 653 (Del. 1975), appeal dismissed, 365 A.2d 136 (Del. 1976), in which the company's articles of incorporation gave to preferred stockholders the right to elect a majority of the company's board of directors in the event of the failure to pay preferred dividends. Under this provision, the preferred stockholders gained control of the company's board of directors and thereafter refused to eliminate the dividend arrearage necessary to meet the threshold for their required relinquishment of their election rights. Suing for relief, the common stockholders alleged that the company had sufficient funds available to permit payment of the arrearage. The proper analysis of this case is the same as the analysis proffered generally in this section. Return to text.

[225] For a good statement of the dividend credit rule (as well as a statement of the contrary rule), see Day, 126 A. at 304-05. Return to text.

[226] Managers' decision to redeem stock typically is detrimental to the interests of preferred stockholders. See supra notes 89-90 and accompanying text. Return to text.

[227] Senior money investors such as preferred stockholders and creditors (and, for that matter, employees) can be harmed by dividends and repurchases of common stock that increase the risk that the company will be unable to meet its obligations to such senior investors. Return to text.

[228] Preferred stockholders whose dividends are in arrears will benefit by the rapid or immediate elimination of the arrearage. Any delay in elimination of the arrearage, therefore, is contrary to the best interests of preferred stockholders. Return to text.

[229] Numerous commentators have noted the different investment objectives of fixed investors and residual investors and the fact that an investment that maximizes the value of the corporation may nonetheless reduce the wealth of fixed investors, who have no right to participate in earnings above their fixed, contractual amount. See, e.g., Hurst & McGuinnis, supra note 117, at 195. Return to text.

[230] See discussion supra part V.B. (especially notes 139-45 and accompanying text). Return to text.

[231] Regarding constituency statutes, see James J. Hanks, Evaluating Recent State Legislation on Director and Officer Liability Limitation and Indemnification, 43 BUS. LAW. 1207 (1988); Alexander C. Gavis, A Framework for Satisfying Corporate Directors' Responsibilities Under State Nonshareholder Constituency Statutes: The Use of Explicit Contracts, 138 U. PA. L. REV. 1451 (1990). Return to text.

[232] In a 1991 article, Professor O'Connor lists the states having constituency statutes. O'Connor, supra note 75, at 1229 n.288. In the same year, Hanks put the number of states adopting constituency statutes at 28. James J. Hanks, Playing with Fire: Nonshareholder Constituency Statutes in the 1990s, 21 STETSON L. REV. 97, 103 (1991). Return to text.

[233] See Hanks, supra note 232, for a description of the variations among states. Return to text.

[234] Constituency statutes protect directors, and some, but not all, cover the actions of officers as well. Id. at 105. Return to text.

[235] O'Connor, supra note 75, at 1194; Hanks, supra note 232, at 106. Return to text.

[236] Connecticut's constituency statute is mandatory. CONN. GEN. STAT. § 33-313(e) (West 1994). Return to text.

[237] Stone, Employees as Stakeholders, supra note 76, at 70. Return to text.

[238] See supra text accompanying notes 75-77. Return to text.

[239] This is not entirely accurate, of course, since it is possible that the mistreatment of another constituency may harm the interests of managers or voting stockholders. For example, an expropriation of creditors' wealth may raise the subsequent cost of capital to the corporation, which would be contrary to the interests of managers and voting stockholders. Return to text.

[240] Even commentators who share a view that fiduciary duties need to be liberalized are less than consistent in their views regarding the efficacy of constituency statutes. Stone, Employees as Stakeholders, supra note 76, at 71, 72 ([S]tatutes have at least "symbolic value"; "despite their weaknesses, the nonshareholder constituency statutes may nonetheless have value."); O'Connor, supra note 75, at 1260 ("Although these statutes have not been tested in the courts, they are a potential source of protection to displaced workers."); McDaniel, supra note 85, at 161 (Statutes are valuable if interpreted with "Pareto efficiency as the economic goal."). For contrary and more negative views about constituency statutes, see Hanks, supra note 232; Macey, supra note 138. Return to text.

[241] Professor Macey makes this argument directly. Macey, supra note 138, at 32 ("[V]irtually any management decision, no matter how arbitrary, can be rationalized on the grounds that it benefits some constituency . . .") (emphasis added). Hanks makes the point somewhat more indirectly. Hanks, supra note 232, at 113-15 (emphasizing the absence of standards and the difficulty of monitoring). Return to text.

[242] See McDaniel, supra note 85; McDaniel, supra note 58. Return to text.

[243] McDaniel, supra note 85, at 121-39. McDaniel also argues that constituency statutes should be interpreted to require that any gains "awarded to stakeholders must bear a reasonable relationship to the benefits received by stockholders." Id. at 136. Return to text.