Monday, July 10, 2006

Corporate Institutionalism and Fiduciary Duty: On Professor Katsuhito Iwai's Nominalistic and Realistic Corporations Model

I recently had the opportunity to reread the article by University of Tokyo Faculty of Economics Professor Katsuhito Iwai, "The Nature of the Business Corporation: Its Legal Structure and Economic Functions," The Japanese Economic Review, 53(3):243-273 (2002). I was particularly intrigued by a number of points raised in that paper that I thought were worth reporting.

Professor Iwai's use of organizational theory to deepen the analysis of “nominalistic” and “realistic” corporations was quite useful. The institutional analysis he suggests provides a necessary counterpoint to the substantially one-dimensional perspective of American law and economics work (Id. 246-256). He builds on the opposing notions of corporations as property (shares in the hands of shareholders) and corporations as entities (juridical personalities owning property, including other corporations, in their own right) to develop two models of corporate character. The first--the nominalistic corporation, is common to market based societies like the United States. The emphasis is on the property character of corporations and transnactions in interests in the corporation. Corporations are things through which money is made. In this environment, law and economics theories of corporations as nexi of contracts make sense. But they fail to explain variations in the free market model in other capitalist states. In thse states, Japan for example, a more institutional model of corporate character better explains the nature of economic organization. In these states, the realistic corpore model predominates. The emphasis is on the institutional character of the entity. These are entities that can, in some circumstances, own themselves (Id., at 254-256). "We have now reached the paradigm of corporate realism. What we have seen is that, by extensive cross shareholdings, a group of corporations can rid themselves of their thingness and become an association of self determining subjects, that is full persons, in the system of law" (Id., 256).

This last insight has tremendous repercussions for the regulation of corporations at the international level. The United States continues to embrace the notion that all corporations are inherently "nominalistic" and that consequentially, the only appropriate form of corporate regulation is state based and limited to the economic function of shareholder profit maximization. Many parts of the rest of the world, however, tend tto view corporations as having more of the character of "realistic" corporations. The regulatory consequences can be significant. The current global "corporate social responsibility movement" is grounded, in part, on the sense that corporations are autonomous economic actors with social and political obligations independent of that of their shareholder "owners."

Professor Iwai uses this distinction between "nominalistic" and "realistic" corporations to apply the organizational theory distinction between corporations whose conception is instrumental in nature and those which are autonomous in nature. "I believe that these two opposing conceptions are not mutually incompatible characterizations of their ideal type, but equally valid representations of their two polar empirical types. SOme organizations are merely instrumental while others are fully autonomous, though most of the organizations we observe in actual society occupy positions in between" (Id., at 262) . Though he argues that the key value of autonomous corporate entities is their "organization specific human assets," (Id., at 264), I wonder, whether it is not possible, at least in some cultures, to maintain a market for these “organization-specific human assets” consistent with his value theory of corporate institutional autonomy. Suppose, for example, that organizational culture posits an ideal type of organization in any given industrial sector. Suppose further that organizations, precisely because they are autonomous, are constantly seeking to “perfect” themselves by adapting their organizational form and culture to approach this ideal type. In such an environment, there might be intense competition for individuals who are perceived to be key members of organizations deemed closer to the ideal type. These individuals would be valuable precisely because of their perceived ability (whether or not the potential can be realized is of course an other matter entirely) to import “organization specific human assets and not for other skills. In societies in which markets for such skills are culturally permitted, institutional autonomy would be strengthened by a healthy market for individuals with organization specific “capital” useful in perfecting less well organized entities.

Professor Iwai also makes the point that the classical agency model doesn’t work in the corporate context because the principal, in this case shareholders, can’t completely eliminate, or at least act, without the agent. This is a valuable insight that often is hardly stressed in the American context. In the rush toward a free-floating contract model, many forget the effect of the state on otherwise free markets for contractual relations. From an institutionalist perspective, he suggests, in effect, that the agent exists as an instrumental actor basic to the organizational form of the corporation (the board of directors) rather than as individual actors (the directors) and that this institutional actor is beholden to the state (the ultimate institutional shareholder) rather than to the individual shareholders themselves as is usually taught. It is the state, rather than the shareholders, that shapes the basic character and duties of the board of directors as institutional agents. And it is the courts, rather than shareholders, who help give context to the obligation of the board of directors as an institution and to directors as individuals. Individuals have a double indirect relation to economic organizations like the corporation—first as shareholders whose power to direct the agent is limited and then as voters who may direct the state itself to affect corporate organizations. This complication is most useful for demonstrating the dependent autonomy of non-political organizations operating among nation-states.

This last point about the role of courts and the fiduciary behavior of directors he elaborates most usefully in Section 8 of the paper (Id., at 260-261). For me, this serves as one of the most important parts of the analysis. Just as directors must be understood as components of an institution with multiple and possibility inconsistent ties, so must officers and managers be understood in their institutional context. What is most interesting about the analysis, and from an American perspective, mostly neglected, is the idea that an absence of self-dealing is impossible among managers because they inevitably always stand of both sides of the monitoring transaction. Of course, this had enormous implications for American law, all of it bad. For example, this insight might well suggest that the whole thrust of the monitoring specific parts of the recently enacted Sarbanes-Oxley Act will be ineffective. Sarbanes-Oxley is grounded in the notion that the state, through a series of rules and formulae, produce in corporations, managers able to act independently. More interesting still, from my perspective, is the value of this insight for duty of loyalty analysis, as it has been developing under the fiduciary duty law of Delaware. Professor Iwai's solution, relying heavily on outsider stakeholders such as banks, employees, suppliers and customers (see Id., 261) is echoed in much of the work of the U.N.’s human rights organizations, which have proposed systems of corporate monitoring relying heavily on elements of civil society.

It will be interesting to see how the Delaware court's struggles with fiduciary duty, and especially with the concept of independence, continues to flounder for failure to confront the reality that, at least at some level, independence is unrealistic. Professor Iwai's insight should serve as a starting point for a different sort of analysis of fiduciary duty and its conception. The same, of course, applies to the great federal law project of imposing standards of independence in the black letter of securities law. Even in the United States, where corporations are conceptualized more as property than as entity, the move toward independence standards may reshape the characterization of the corporate form (perhaps pushing it more towards an institutional model).

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