An Economic Analysis of Shared Property in Partnership and Close Corporations Law
Armour, John, Whincop, Michael J., Journal of Corporation Law
The small firm has engaged the attention of law reformers in the United States for the last decade. Close corporation reform continues in many states, and the revisions to uniform partnership law, resulting in the Revised Uniform Partnership Act (RUPA),1 have been well publicized. In addition to reform of "traditional" business forms, recent
years have seen the emergence of new business forms in U.S. jurisdictions, such as the Limited Liability Company (LLC)2 and the Limited Liability Partnership (LLP).3 Similar reform efforts are now under way in Europe. In the United Kingdom, the recent Review of Company Law has made the needs of small companies one of its "core concerns."4 Partnership law is currently under review in the United Kingdom for the first time in over a hundred years5 and reforms are also imminent in other European jurisdictions such as the Netherlands.6 Furthermore, the proliferation of new statutory forms appears to be spreading to Europe with the introduction of the U.K. Limited Liability Partnerships Act.7
The task of the law reformer working in this area is a complex one. Small firms are very different from widely-held, exchange-traded firms, where wealth-maximizing governance institutions are obstructed by endemic collective action problems and high agency costs. The small firm differs radically in the capability of investors to be actively involved in the design of governance processes that lower agency costs.8 The lawmaker must focus on what role the law can uniquely serve in small firms without duplicating what parties can do for themselves.
Economic analysis of law has conventionally approached this question by explaining how the relations between investors, creditors, and managers are contractual and illustrating the governance problems arising from these incomplete contracts.9 Its exponents often conclude that the functional role the law can serve in small firms is limited to the lower-order function of decreasing transaction costs by plugging gaps in contracts with suitable default rules.10 Yet this leaves a nagging question unanswered: Why does the state have a comparative advantage in the supply and enforcement of these terms over private interest groups and arbitrators, who respectively supply standard terms for, and adjudicate disputes arising under, other varieties of relational contract?11 When "rule competition"--both between jurisdictions and between public and private suppliers of terms-is included in the equation, the role of the statutory law reformer seems increasingly marginal. 12
Our answer to this problem rests in an appreciation of the law's role in giving proprietary effect to the entitlements that the participants share. With a few exceptions, law and economics scholarship has failed to consider the proprietary foundations of intrafirm governance. This neglect is surprising. These proprietary foundations are the most important instance where law performs a unique function, a function neither Coasean trade nor private provision can easily emulate.13 A study of proprietary entitlements offers promise for uniting developments in the economics of the firm with legal scholarship.14 Finally, the principal organizational alternatives for small firms-- close corporations and partnerships-are most meaningfully differentiated according to the proprietary effect those firms give to organizational entitlements.
At the outset, it should be made clear that this analysis is an internal critique that extends the existing theory. Consequently, it does not consider social objectives of the state other than facilitation of private parties' goals. This does not imply that other social goals are considered irrelevant. On the contrary, a proprietary analysis provides more scope for considering, for example, issues of distribution than does a contractarian model.15 A study of how the law can most efficiently facilitate parties' goals is nevertheless useful for two reasons. …