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| Background reading - Theory
of the Firm More
than 200 years ago Adam
Smith in his book Wealth of Nations described why individuals
voluntarily organize together in teams to produce goods. |
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To
take an example, therefore, from a very trifling manufacture; but one
in which the division of labour has been very often taken notice of, the
trade of the pinmaker; a workman not educated to this business (which
the division of labour has rendered a distinct trade), nor acquainted
with the use of the machinery employed in it (to the invention of which
the same division of labour has probably given occasion), could scarce,
perhaps, with his utmost industry, make one pin in a day, and certainly
not make twenty. But in the way in which this business is now carried
on, not only the whole work is a peculiar trade, but it is divided into
a number of branches, of which the greater part are likewise peculiar
trades. One man draws out the wire, another straightens it, a third cuts
it, a fourth points it, a fifth grinds it at the top for receiving the
head; to make the head requires two or three distinct operations; to put
it on, is a peculiar business, to whiten the pins is another; it is even
a trade by itself to put them into the paper; and the important business
of making a pin is, in this manner, divided into about eighteen distinct
operations, which, in some manufactories, are all performed by distinct
hands, though in others the same man will sometimes perform two or three
of them. I have seen a small manufactory of this kind where ten men only
were employed, and where some of them consequently performed two or three
distinct operations. But though they were very poor, and therefore but
indifferently accommodated with the necessary machinery, they could, when
they exerted themselves, make among them about twelve pounds of pins in
a day. There are in a pound upwards of four thousand pins of a middling
size. Those ten persons, therefore, could make among them upward of forty-eight
thousand pins in a day. Each person, therefore, making a tenth part of
forty-eight thousand pins, might be considered as making four thousand
eight hundred pins in a day. But if they had all wrought separately and
independently, and without any of them having been educated to this peculiar
business, they certainly could not each of them have made twenty, perhaps
not one pin in a day that is, certainly, not the two hundred and fortieth,
perhaps not the four thousand eight hundredth part of what they are at
present capable of performing, in consequence of a proper division of
and combination of their different operations. Adam
Smith, The Wealth of Nations 6-7 (1776) (E. Cannan ed. 1937).
Assume the owners of Pin Company (PinCo)
decide to expand their business to take advantage of the latest pinmaking
technology. They want to buy new machines, hire even more workers
and build a new sparkling factory as monuments to their ingenuity and
human worth. They also hope to make even more money.. The
PinCo owners, all old guard capitalists, look in their own pockets for
new capital and find no more than a few tarnished coins of a bygone
era. They then turn to their capitalist of traditional choice,
the Local Bank, and are told that their expansion plans are too risky;
Local Bank would lend them money only at usurious rates of interest.
They turn to their benevolent government, the State of Sovereign, but
the State has chosen to stay out of private enterprise.
What can the PinCo owners do? They consider a new
source of capital: the rising savings of middle-income merchants
and professionals. These new capitalists might be willing to take
on some risks, if promised potentially big returns. (Remember
that corporate stock is merely a set of rights that promise a return
on investment.)
Investors agree to talk with the PinCo entrepreneurs
-- hypothetically, of course. After the usual pleasantries, the
two groups begin to hash out a legal and commercial relationship.
The PinCo entrepreneurs insist on managing the business-- they talk
incessantly about discretion and their own managerial genius.
The investors insist on protection for their investment--they talk about
opportunism and the risk of disloyal managers. The managers bluster
and pound the table; the investors smirk and wave their wads of cash.
What terms will facilitate this relationship so that
it will be an attractive vehicle for the parties to invest their human
and cash capital? What terms will they agree on? The entrepreneurs
insist on management powers over such matters as cash flow, management
personnel, scope of the business, types of assets, new capital, new
investors, changes in management. They ask with irony, "Do you
think you could run a state-of-the-art pin company?"
The investors are aghast and insist on limits.
They ask back, "Do you really think we're going to throw our money away
at your dreams or, worse, into your pockets?" They insist on assurances
of managerial good faith, limits on changes in the business, protection
against dilution of their investment, limits on amount of their money
at risk, and so on.
The negotiations continue -- for two centuries.
What comes out? Today there is an alphabet soup: general
partnerships (GP), limited partnerships (LP), limited liability companies
(LLC), limited liability partnerships (LLP), limited liability limited
partnerships (LLLP), publicly held corporations (PHC), closely held
corporations (CHC), professional corporations (PC), professional limited
liablity partnerships (PLLP) -- to name a few. They constitute
pre-packaged investment vehicles offered by state legislatures, subject
to signficant customization by the parties. These packages provide
(sometimes for a fee) --
- entity status
- capital structures - financial rights
- shareholder voting rights
- management powers (and duties)
- transferability rights
- procedures for change
- liability (and limits) to outside parties
A constant in all the packages is judicial oversight
of the participants' rights and duties.
Before we spend a semester looking at the current status
of modern business organizations, we should pause and consider how the
negotiations between the PinCo managers and the investors should come
out. As a manager what terms would you want? As an investor?
What is the likely outcome?
Below is the table of contents of one current agreement
between investors (shareholders) and managers (directors and officers)
-- the Model Business Corporation Act (1984, as amended). From
this table of contents, can you identify the seven elements of the corporate
contract?
CHAPTER 1.
GENERAL PROVISIONS
Subchapter A.
Short Title and Reservation of Power
§ 1.01. Short Title
§ 1.02. Reservation of Power to Amend or Repeal
Subchapter B. Filing Documents
§ 1.20. Filing Requirements
§ 1.21. Forms
§ 1.22. Filing, Service and Copying Fees
§ 1.23. Effective Time and Date of Document
§ 1.24. Correcting Filed Document
§ 1.25. Filing Duty of Secretary of State
§ 1.26. Appeal form Secy's Refusal to File
Document
§ 1.27. Evidentiary Effect of Copy of Filed
Document
§ 1.28. Certificate of Existence
§ 1.29. Penalty for Signing False Document
Subchapter C. Secretary of State
§ 1.30. Powers
Subchapter D. Definitions
§ 1.40. Act Definitions
§ 1.41. Notice
§ 1.42. Number of Shareholders
CHAPTER 2. INCORPORATION
§ 2.01. Incorporators
§ 2.02. Articles of Incorporation
§ 2.03. Incorporation
§ 2.04. Liability for Preincorporation Transactions
§ 2.05. Organization of Corporation
§ 2.06. Bylaws
§ 2.07. Emergency Bylaws
CHAPTER 3. PURPOSES AND POWERS
§ 3.01. Purposes
§ 3.02. General Powers
§ 3.03 Emergency Powers
§ 3.04. Ultra Vires
CHAPTER 4. NAME
§ 4.01. Corporate Name
§ 4.02. Reserved Name Power to Amend or Repeal
§ 4.03. Registered Name
CHAPTER 5. OFFICE AND AGENT
§ 5.01. Registered Office and Registered Agent
§ 5.02. Change of Registered Office or Agent
§ 5.03. Resignation of Registered Agent
§ 5.04. Service on Corporation
CHAPTER 6. SHARES AND DISTRIBUTIONS
Subchapter A. Shares
§ 6.01. Authorized Shares
§ 6.02. Terms of Class or Series Determined by
Board of Directors
§ 6.03. Issued and Outstanding Shares
§ 6.04. Fractional Shares Subchapter
B. Issuance of Shares
§ 6.20. Subscription for Shares before Incorporation
§ 6.21. Issuance of Shares
§ 6.22. Liability of Shareholders
§ 6.23. Share Dividends
§ 6.24. Share Options
§ 6.25. Form and Content of Certificates
§ 6.26. Shares without Certificates
§ 6.27. Restriction on Transfer of Shares,
Securities
§ 6.28. Expense of Issue
Subchapter C. Subsequent Acquisition of
Shares by Shareholder and Corporation
§ 6.30. Shareholders' Preemptive Rights
§ 6.31. Corporation's Acquisition of its own
Shares
Subchapter D. Distributions
§ 6.40. Distributions to Shareholders
CHAPTER 7. SHAREHOLDERS
Subchapter A. Meetings
§ 7.01. Annual Meeting
§ 7.02. Special Meeting
§ 7.03. Court-ordered Meeting
§ 7.04. Action Without Meeting
§ 7.05. Notice of Meeting
§ 7.06. Waiver of Notice
§ 7.07. Record Date Subchapter
B. Voting
§ 7.20. Shareholders' List for Meeting
§ 7.21. Voting Entitlement of Shares or Repeal
§ 7.22. Proxies
§ 7.23. Shares Held by Nominees
§ 7.24. Corporation's Acceptance of Votes
§ 7.25. Quorum and Voting Requirements for
Voting Groups
§ 7.26. Action by Single and Multiple Voting
Groups
§ 7.27. Greater Quorum or Voting Requirements
§ 7.28. Voting for Directors; Cumulative Voting
Subchapter C. Voting Trusts and Agreements
§ 7.30. Voting Trusts
§ 7.31. Voting Agreements
§ 7.32. Shareholder Agreements
Subchapter D. Derivative Proceedings
§ 7.40. Subchapter Definitions
§ 7.41. Standing
§ 7.42. Demand
§ 7.43. Stay of Proceedings
§ 7.44. Dismissal
§ 7.45. Discontinuance or Settlement
§ 7.46. Payment of Expenses
§ 7.47. Applicability to Foreign Corporations
CHAPTER 8. DIRECTORS
AND OFFICERS
Subchapter A.
Board of Directors
§ 8.01. Requirement for and Duties of Board of
Directors
§ 8.02. Qualifications of Directors
§ 8.03. Number and Election of Directors
§ 8.04. Election of Directors by Classes of Shareholders
§ 8.05. Terms of Directors Generally
§ 8.06. Staggered Terms for Directors
§ 8.07. Resignation of Directors
§ 8.08. Removal of Directors by Shareholders
§ 8.09. Removal of Directors by Judicial Proceeding
§ 8.10. Vacancy on Board
§ 8.11. Compensation of Directors Subchapter
B. Meetings and Actions of the Board
§ 8.20. Meetings
§ 8.21. Action Without Meeting
§ 8.22. Notice of Meeting
§ 8.23. Waiver of Notice
§ 8.24. Quorum and Voting
§ 8.25. Committees
Subchapter C. Standards of Conduct
§ 8.30. General Standards for Directors
§ 8.31. [reserved]
§ 8.32. [reserved]
§ 8.33. Liability for Unlawful Distributions
Subchapter D. Officers
§ 8.40. Required Officers
§ 8.41. Duties of Officers
§ 8.42. Standards of Conduct for Officers
§ 8.43. Resignation and Removal of Officers
§ 8.44. Contract Rights of Officers
Subchapter E. Indemnification
§ 8.50. Subchapter Definitions
§ 8.51. Authority to Indemnify
§ 8.52. Mandatory Indemnification
§ 8.53. Advance for Expenses
§ 8.54. Court-Ordered Indemnifciation
§ 8.55. Determination / Authorization of Indemnification
§ 8.56. Indemnification of Officers, Employees,
Agents
§ 8.57. Insurance
§ 8.58. Application of Subchapter
Subchapter F. Directors' Conflicting Interest
Transactions
§ 8.60. Subchapter Definitions
§ 8.61. Judicial Action
§ 8.62. Directors' Action
§ 8.63. Shareholders' Action |
CHAPTER 9. DOMESTICATION
AND CONVERSION
Subchapter A. Preliminary Provisions
§ 9.01. Excluded transactions
§ 9.02. Required approvals
Subchapter B. Domestication
§ 9.20. Domestication
§ 9.21. Action on Plan of Domestication
§ 9.22. Articles of Domestication
§ 9.23. Surrender of Charter upon Domesticatoin
§ 9.24. Effect of Domestication
§ 9.25. Abandonment of Domestication
Subchapter C. Nonprofit Conversion
Subchapter D. FOreign Nonprofit Domestication and Conversion
Subchatper E. Entity Conversion
CHAPTER 10. AMENDMENT
OF ARTICLES OF INCORPORATION AND BYLAWS
Subchapter
A. Amendment of Articles of Incorporation
§ 10.01. Authority to Amend
§ 10.02. Amendment by Board of Directors
§ 10.04. Amendment by Board of Directors and Shareholders
§ 10.05. Voting on Amendments by Voting Groups
§ 10.06. Amendment Before Issuance of Shares
§ 10.07. Articles of Amendment
§ 10.08. Restated Articles of Incorporation
§ 10.09. Effect of Amendment Subchapter
B. Amendment of Bylaws
§ 10.20. Amendment by Board of Directors or Shareholders
§ 10.21. Bylaws Increasing Quorum or Voting Requirement
for Shareholders
§ 10.22. Bylaw Increasing Quorum or Voting Requirement
for Directors
CHAPTER 11. MERGER AND
SHARE EXCHANGE
§ 11.01. Merger
§ 11.02. Share Exchange
§ 11.03. Action on Plan
§ 11.04. Merger of Subsidiary
§ 11.05. Articles of Merger or Share Exchange
§ 11.06. Effect of Merger of Share Exchange
§ 11.07. Merger or Share Exchange with Foreign Corporation
CHAPTER 12. SALE
OF ASSETS
§ 12.01. Sale of Assets in Regular Course of Business
and Mortgage of Assets
§ 12.02. Sale of Assets Other Than in Regular Course
of Business
CHAPTER
13. DISSENTERS' RIGHTS
Subchapter
A. Right to Dissent and Obtain Payment for Shares
§ 13.01. Definitions
§ 13.02. Right to Dissent
§ 13.03 Dissent by Nominees and Beneficial Owners
Subchapter B. Procedure for Exercise of
Dissenters' Rights
§ 13.20. Notice of Dissenters' Rights
§ 13.21. Notice of Intent to Demand Payment
§ 13.22. Dissenters' Notice
§ 13.23. Duty to Demand Payment
§ 13.24. Share Restrictions
§ 13.25. Payment
§ 13.26. Failure to Take Action
§ 13.37. After-Acquired Shares
§ 13.28. Procedure if Shareholder Dissatisfied with
Payment or Offer
Subchapter C. Judicial Appraisal of Shares
§ 13.30. Court Action
§ 13.31. Court Costs and Counsel Fees
CHAPTER 14. DISSOLUTION
Subchapter A. Voluntary Dissolution
§ 14.01. Dissolution by Incorporators or Initial Directors
§ 14.02. Dissolution by Board of Directors and Shareholders
§ 14.03. Articles of Dissolution
§ 14.04. Revocation of Dissolution
§ 14.05. Effect of Dissolution
§ 14.06. Unknown Claims Against Dissolved Corporation
§ 14.07. Unknown Claims Against Dissolved Corporation
Subchapter B. Administrative Dissolution
§ 14.20. Grounds for Administrative Dissolution
§ 14.21. Procedure for and Effect of Administrative
Dissolution
§ 14.22. Reinstatement Following Administrative Dissolution
§ 14.23. Appeal form Denial of Reinstatement
Subchapter C. Judicial Dissolution
§ 14.30. Grounds for Judicial Dissolution
§ 14.31. Procedure for Judicial Dissolution
§ 14.32. Receivership or Custodianship
§ 14.33. Decree of Dissolution
§ 14.34. Election to Purchase in Lieu of Dissolution
Subchapter D. Miscellaneous
§ 14.40. Deposit with State Treasurer
CHAPTER 15. FOREIGN CORPORATIONS
Subchapter A. Certificate of Authority
§ 15.01. Authority to Transact Business Required
§ 15.02. Consequence of Transacting Business Without
Authority
§ 15.03. Application for Certificate of Authority
§ 15.04. Amended Certificate of Authority
§ 15.05. Effect of Certificate of Authority
§ 15.06. Corporate Name of Foreign Corporation
§ 15.07. Registered Office and Registered Agent of
Foreign Corporation
§ 15.08. Change of Registered Office or Registered
Agent of Foreign Corporation
§ 15.09. Resignation of Registered Agent of Foreign
Corporation
§ 15.10. Service on Foreign Corporation Subchapter
B. Withdrawal and Reservation of Power
§ 15.20. Withdrawal of Foreign Corporation
Subchapter C. Revocation of Certificate
of Authority
§ 15.30. Grounds for Revocation
§ 15.31. Procedure for and Effect of Revocation
§ 15.32. Appeal from Revocation
CHAPTER 16. RECORDS AND
REPORTS
Subchapter A. Records
§ 16.01. Corporate Records
§ 16.02. Inspection of Records by Shareholders
§ 16.03. Scope of Inspection Rights
§ 16.04. Court-Ordered Inspection Subchapter
B. Reports
§ 16.20. Financial Statements for Shareholders
§ 16.21. Other reports to Shareholders
§ 16.22. Annual Report for Secretary of State
CHAPTER 17. TRANSITION PROVISIONS
§ 17.01. Application to Existing Domestic Corporations
§ 17.02. Application to Qualified Foreign Corporations
§ 17.03. Savings Provisions
§ 17.04. Severability
§ 17.05. Repeal
§ 17.06. Effective Date |
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